What You Need to Know About Buying Exchange-Traded Funds
Investing can be approached in a simple fashion with exchange-traded funds (ETFs). Exchange-traded funds (ETFs) are easy to learn about and use, and they can yield high returns with little outlay of time or money. Learn more about exchange-traded funds (ETFs) and how to invest in them below.
Defining Exchange-Traded Funds:
Investing in an ETF is a great way to bulk out your stock or bond holdings. When people put their money into ETFs, the money is invested in a diversified portfolio that aims to achieve a specific goal. When you invest in an exchange-traded fund (ETF), your money is spread out among the 500 companies that make up a certain index.
Differences Between Exchange-Traded Funds and Traditional Mutual Funds:
Since the underlying concept of ETFs and mutual funds is similar, investors often wonder what sets them apart.
The primary distinction between these two investment types is the means through which they are bought and sold. Mutual funds’ prices are calculated once daily, and most investors put down a specific amount. The main factor to remember about buying mutual funds is that the transaction is not quick, regardless of whether you do it through a brokerage or straight from the issuer.
However, ETFs are traded on major exchanges like the NYSE and Nasdaq much like regular equities. You don’t put down a lump sum, but rather decide how many shares to buy at a time. To keep up with the ever-changing stock market, you can acquire shares of an exchange-traded fund (ETF) whenever the stock market is open.
Exchange-Traded Funds: A Primer:
There are a few fundamental ideas you should grasp before investing in your first exchange-traded fund (ETF).
- Differences between passive and active exchange-traded funds: ETFs can be broken down into two categories. Passive exchange-traded funds, or index funds, are those that do nothing more than mirror the performance of a stock market index like the S&P 500. The money in active ETFs is invested by professional “portfolio managers.” One must remember that the goal of passive ETFs is to replicate the performance of an underlying index. Unlike passive ETFs, active ETFs aim to outperform their respective index.
- Measures of cost effectiveness: The expense ratio is the cost investors must pay when using an exchange-traded fund. The expense ratio is expressed as a yearly percentage and may be found in the table. For every $1,000 you invest, for instance, you will be charged $10 in fees if the expense ratio is 1%. When all other factors are held constant, a lower expense ratio means more savings.
- Distribution Reinvestment Plans and Dividends: Dividends are distributed by most ETFs. Your dividends from exchange-traded funds (ETFs) can be paid to you in cash or automatically reinvested through a dividend reinvestment plan (DRIP).
Investing in Exchange-Traded Funds and Taxes:
Investing in exchange-traded funds (ETFs) through a regular brokerage account (rather than an individual retirement account) may generate taxable income. You will be subject to capital gains tax regulations on any profits made from selling an ETF, and similar laws apply to any dividends you receive.
Obviously, you won’t have to pay taxes on capital gains or dividends if you invest in ETFs in your IRA. Investments made in a Roth IRA are not subject to taxation under most circumstances, but withdrawals from a regular IRA are taxed as ordinary income.
Approximately how much do you need to put money into exchange-traded funds?
Unlike mutual funds, exchange-traded funds (ETFs) do not impose initial investment thresholds. However, exchange-traded funds (ETFs) trade on a per-share basis, so you’ll need at least the current price of one share to get started unless your broker allows you to buy fractional shares of stock.
Arguments for and against using exchange-traded funds:
ETFs offer several benefits for investors.
- Exchange-traded funds (ETFs) allow investors to gain cheap and diversified exposure to the stock and bond markets as well as other asset classes.
- With ETFs, investors no longer have to assume risks when purchasing stocks. This way, investors can get the same long-term returns as the market, which have been impressive.
- Compared to mutual funds, ETFs are more liquid, meaning they are easier to purchase and sell. Using an online broker, buying and selling ETFs is as easy as clicking a mouse.
- When it comes to the fixed-income element of your portfolio, investing in individual bonds can be incredibly challenging, but a bond ETF can simplify things greatly.
Investments in ETFs may have the following potential drawbacks:
- As a result of investing in a basket of companies rather than a single firm, exchange-traded funds (ETFs) do not offer the same return potential as direct stock ownership would.
- Despite their cheap prices, ETFs aren’t always free. It is possible to avoid paying management fees entirely by assembling a stock portfolio yourself.
Tips for Getting Started with Exchange-Traded Funds:
- Start trading with a brokerage account.
- Pick out some initial exchange-traded funds.
- Put your trust in exchange-traded funds.
Step1: Register for a Trading Account
First, open a brokerage account so you may trade ETFs in and out. Trading stocks and ETFs no longer often incurs a commission fee, and most online brokers now do so as well. The smartest move is to evaluate each broker’s services and software separately. There are a number of great brokers out there, but if you’re just starting off, one that offers a lot of instructional resources, like TD Ameritrade (NASDAQ:AMTD), E*Trade (NASDAQ:ETFC), or Schwab (NYSE:SCHW), is a smart bet.
Step2: Pick out some initial exchange-traded funds.
To get started investing, index funds that require little to no active management are recommended. Most actively managed funds underperform their benchmark index over time, and as a result, index funds are more cost-effective than their actively managed equivalents.
Accordingly, for those just getting their feet wet in the world of investing, I’ve compiled the following exchange-traded fund (ETF) list along with a quick explanation of the types of assets each ETF invests in:
Example Exchange Traded Funds: Top 10 ETFs for Novices:
- To invest in large U.S. corporations, consider the Vanguard S&P 500 ETF (NYSEMKT:VOO).
- Mid-sized U.S. corporations represented by the Schwab U.S. Mid-Cap ETF (NYSEMKT:SCHM).
- Smaller U.S. corporations represented by the Vanguard Russell 2000 ETF (NYSEMKT:VTWO).
- SCHF, the Schwab International Equity ETF (NYSEMKT), invests in large corporations based in countries other than the United States.
- Companies based in countries with emerging economies are represented in the Schwab Emerging Markets Equity ETF (NYSEMKT:SCHE).
- The Vanguard High-Dividend ETF (NYSEMKT:VYM) consists of companies that have dividends that are higher than the market average.
- Real Estate Investment Trusts (REITs) traded on the New York Stock Exchange (NYSEMKT) with the ticker symbol “Schwab U.S. REIT ETF” (
- Bonds of various maturities and issuers comprise the Schwab U.S. Aggregate Bond ETF (NYSEMKT:SCHZ).
- The Vanguard Total International Bond Fund (NASDAQ: BNDW) — Bonds issued by the United States of America, as well as bonds issued by other countries, are included.
- The Nasdaq-100 Index is skewed toward technology and other growth stocks, which Invesco QQQ Trust (NASDAQ:QQQ) mimics.
In particular, Vanguard and Schwab appear frequently here. For good reason, too: both are committed to providing Americans with low-cost stock market access, and thus, ETFs from both are frequently among the industry’s least expensive.
Stop worrying and let your ETFs do the heavy lifting:
Keep in mind that exchange-traded funds are typically created as hands-off investments.
Those who are just starting out in the investment world have a poor habit of checking their accounts too frequently and reacting emotionally and rashly to market shifts. Most fund investors underperform the market over time due to excessive trading. Therefore, if you have purchased shares in some great ETFs, it is better to let them do what they were designed to do, which is to generate excellent financial gains over extended periods of time while you do nothing.