There are many investment options – no matter if you’re a beginner or a seasoned investor. The sheer amount of choices can be overwhelming.
So, to get you started, today I’ll be discussing one of the best investments for beginners – ETFs. Compared to other investment options, ETFs are easy to understand.
So, without further ado, let’s get started!
What’s Ahead:
What is an ETF?
ETF stands for exchange-traded fund. An ETF allows you to purchase a large number of securities – stocks, bonds or commodities – all at once.
You can think of an ETF like a grocery basket but instead of filling your basket with eggs and milk, you fill it with stocks or bonds. And, instead of purchasing each item individually, you purchase the entire basket all in one go!
Like an individual stock, ETFs are traded on an exchange throughout the day and there are tons of ETFs to choose from. Some ETFs are full of stocks, some hold bonds, and other track the performance of a certain market sector (health care, pharmaceuticals or communications) or a certain index (S&P 500 or Dow Jones).
ETF vs. mutual funds
You might be thinking that an ETF sounds a bit like a mutual fund and, while they do share a few things in common, they also have their differences.
They both let you buy different securities
ETFs and mutual funds are similar in that they both allow you to purchase a large number of securities (stocks, bonds) all at one time.
Not only is this convenient but it also helps to add diversification. By purchasing a mutual fund or ETF you are essentially buying a basket of securities that holds an array of stocks and bonds as opposed to purchasing just one or a few.
ETFs trade multiple times per day, mutual funds just once
The main difference between an ETF and a mutual fund is that ETFs trade throughout the day on the market, like a stock. On the other hand, mutual funds only trade once per day, after the market has closed.
ETFs tend to be cheaper
Another difference is that ETFs are generally cheaper than mutual funds because they tend to have lower management fees. The majority of ETFs are passively managed. This means that people buy and hold an ETF that tracks an entire index with the goal of mirroring the market. Because this is a long term strategy there is little in the way of buying and selling which helps to keep fees low.
Many mutual funds are actively managed, which means a fund manager is actively picking investments and trying to outperform the market. As a result of the human effort involved as well as more frequent buying and selling, which result in fees, this option costs more money!
ETFs have lower minimum investment requirements
Lastly, ETFs require a lower minimum investment than a mutual fund. If you want to purchase an ETF you just need to cover the cost of the ETF plus any associated fees or commissions.
This means you can get into the market for a matter of dollars. On the other hand, most mutual funds have much higher fees that require a minimum investment of hundreds or thousands of dollars.
Pros and cons of ETFs
You might be thinking, “Wow, ETFs sound pretty great!” And you’re right, ETFs are great — but they’re not perfect. Before you decide if an ETF is right for you, consider the pros and cons.
Pros
- Low barrier to entry – There is no minimum amount required to begin investing in ETFs. All you need is enough to cover the price of one share and any associated commissions or fees.
- Diversification – Rather than try to purchase every security individually (which would be extremely time consuming), you can quickly and easily purchase one ETF that contains an array of securities.
- Easy to buy and sell – ETFs are traded just like an individual stock. You can buy and sell at any point throughout the day.
- Tax-efficient – You don’t pay any taxes until you sell your ETFs at a profit. So you are in control of when you decide to sell and pay the necessary taxes.
Cons
While ETFs are pretty great, nothing is perfect. There are a few things to be aware of.
- Trading costs – while one of the benefits of ETFs is that they typically have lower fees than mutual funds, you still might have to pay fees when you make a trade. Although a lot of discount brokerages have instituted zero-fee trading, not all have.
- Volatility – ETFs are not immune to volatility. While purchasing an ETF may be more stable than putting all of your money into an individual stock, there is still potential for swings in the market. You can reduce your risk by purchasing an ETF that tracks the entire market (S&P 500 or Dow Jones) rather than purchasing ETFs in one market.
How do I buy an ETF?
Set up an investment account
To purchase an ETF you need to set up an investment account, specifically a brokerage account. You can choose a full-service account where you will have access to a financial advisor who will give you advice and buy the ETFs on your behalf.
If you feel confident doing things yourself and you want to save on fees then you can open an online discount brokerage account and purchase ETFs for yourself.
If you want to open a discount brokerage account but don’t know where to start, you can check out two of the best accounts below.
TD Ameritrade
With TD Ameritrade you can quickly open an online brokerage account and start trading in no time.
There is no minimum account balance and there are no trading fees for online stock and ETF trades. That means all of your investment earnings, go straight into your pocket.
Plus, if you need a little investing help, TD Ameritrade has an array of tools at your disposal.
Fidelity
Fidelity also offers commission-free online trades of stocks, options, and ETFs and there is no annual account fee.
Fidelity also offers their investors access to research and monitoring tools that you can use to help you decide which ETF is right for you.
Now, if you feel a bit intimidated with the idea of opening a discount brokerage and buying ETFs all by yourself but you also don’t want to pay the fees associated with a full-service account – there is another option!
Use a robo-advisor
You can also look into investing with a robo-advisor.
A robo-advisor is a digital platform that uses algorithms to assist you in choosing and managing your investments. A robo-advisor provides many of the same services as a full-service account manager but in the place of the human advisor is software!
Don’t worry, it’s not all about software and robots, robo-advisors still staff humans to design the algorithms, answer your questions, and help you out.
Here are two of the best robo-advisor options:
Betterment
If you’re interested in a robo-advisor you can check out Betterment. Betterment charges an annual fee of 0.25% on your balance in any investment or retirement account. This works out to $25 per year for every $10,000 you have invested.
Plus, Betterment accounts do not require a minimum balance. If you want to learn more about Betterment check out this in-depth review.
Determine what type of ETF you want to buy
If you’ve decided to go the DIY route and purchase ETFs on your own then your next step is to do some research.
Do you want an ETF that follows an index like the S&P 500 or perhaps you are interested in ETFs that track a certain market sector like tech or energy? Many discount brokerage accounts provide research and screening tools that will help you to review and compare different ETFs on things like performance and fees.
This process can be overwhelming, especially for a beginner. If you’re a first-time buyer you might want to consider a low-cost ETF that tracks an index like the S&P 500.
Decide how much you want to spend
Decide how much you can afford to spend and how you want to invest your money.
A lump-sum payment might be the better financial option, especially if you want to avoid fees and commissions associated with trading an ETF. However, dollar-cost averaging is another investment strategy that you can consider.
Dollar-cost averaging involves making regular, scheduled investments (weekly, monthly, quarterly). The main benefit of dollar-cost averaging is that you don’t end up making a big investment when the market is high. By splitting up the payments you will make some purchases when the price is high and some when the price is low, so it helps to average things out!
Because many ETFs charge a sales commission on the purchase or sale, make sure you research the costs to see if dollar-cost averaging is worth it.
Fund your account
Before you can purchase an ETF you need to make sure that you’ve deposited money into your account.
You can fund your account by transferring money from your chequing or savings account or by writing a check. Be aware that this process can take a few days but once the money is in the account you are ready to start investing!
Make a purchase
You’ve opened your brokerage account, spent some time researching ETFs, and now it’s time to execute an order.
The first thing you will need to do is enter the ticker symbol for the ETF you would like to purchase. The ticker symbol is a series of letters that represent the security you are trying to buy. For example, if you’re looking for an ETF that tracks the S&P 500 you might be interested in the Vanguard S&P 500 ETF. This ETF has the ticker symbol “VOO.”
Other things you will need to know to buy an ETF Include:
- Ask price – This is the lowest price the seller is willing to accept for the ETF.
- Bid price – This is the amount a buyer is willing to pay for the ETF.
- Quantity – How many shares do you want to purchase? Let’s say you want to spend $200. To figure out how many shares you can afford you simply divide $200 by the cost of the ETF – let’s say it costs $40 a share ($200/ $40 = 5).
- Order type – The “order” is responsible for providing instructions in regards to how you want to purchase the ETF. The two most common order types are a market or limit order.
- A market order allows you to buy an ETF immediately at the market price. The good thing about a market order is that your order will be filled quickly. However, there is no guarantee on the price.
- With a limit order, you specify the price you are willing to pay for the ETF and the order is only fulfilled when that price (or lower) is reached. So, the price is guaranteed however, if that price isn’t available then your order will not be executed.
- Time in force – This allows you to define how long your order will remain active before it expires. If any terms are unfamiliar to you when you go to purchase an ETF you can look them up on the brokerage site, google them or call the brokerage and speak with a person. After you’ve filled in your order, and carefully reviewed it to ensure everything is correct, you’re ready to hit the buy button!
Give yourself a high five
You did it – congratulations! Buying your first ETF can be intimidating. As you can see, the actual process is pretty simple. It’s taking that first step and committing to the purchase that can be a challenge.
What is the best way to invest in ETFs?
With a large number of ETFs available it can be difficult to determine which ETFs are best. Honestly, the answer will be different for each investor depending on things like preference, interest, risk tolerance, level of expertise…and so on.
However, there are some characteristics that you can look for when purchasing ETFs:
Commission-free ETFs
Trading costs which are the fees associated with purchasing and selling an ETF, add up over time. Especially if you’re using a technique like dollar-cost averaging. If your goal is to keep fees as low as possible be sure to look for commission-free ETFs. Most brokerages offer commission-free ETFs. Both TD Ameritrade and Fidelity offer zero commission-free online trades of stocks and ETFs
Diversification
As you begin to purchase more ETFs it’s important to ensure that you are diversifying your ETF portfolio. This means, don’t put all your eggs in one ETF basket. While ETFs in themselves are more diversified than simply buying an individual stock, you still want to ensure you are purchasing ETFs from different market sectors, buying into small, mid and large-cap companies and possibly looking into ETFs in international or emerging markets.
To learn more about how to diversify your investment portfolio, check out this article.
Passive investing
If you’re looking to invest in the long run then low fee index ETFs might be a good fit. You can purchase an ETF that tracks an entire sector or index.
By taking a long term, passive approach you can avoid trading fees and also increase the tax efficiency of your ETF portfolio.
Summary
There you have it – an overview of what you need to know to embark on your ETF investing journey! ETFs are a great asset to add to your overall investments. They provide an easy way to build a low cost, low effort, and diversified portfolio.
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