Have you ever wanted the relative safety of
mutual fund without the fees and restrictions tied to it?
If so then your answer maybe an ETF.
Exchange-traded funds or ETFs
are an easy way to begin investing.
ETFs are fairly simple to understand and can generate
impressive returns without much expense or effort.
Hi. I am Kate from The Motley Fool.
I'm going to explain what you should know about ETFs,
how they work and how to buy them.
An exchange-traded fund or ETF allows
investors to buy many stocks or bonds at once.
Investors buy shares of ETFs and
the money is used to invest
according to a certain objective.
For example, if you buy an S&P 500 ETF,
your money will be invested in
the 500 companies in that index.
One common question is,
how do ETFs and mutual funds
differ since the basic principles are the same?
The key difference between
these two investment vehicles
is how you buy and sell them.
Mutual funds are priced once per
day and you typically invest a set dollar amount.
Mutual funds can be purchased through
a brokerage or directly from the issuer,
but the key point is that
the transaction is not instantaneous.
On the other hand, ETFs trade just like stocks on
major exchanges such as
the New York Stock Exchange or NASDAQ.
Instead of investing a set dollar amount,
you choose how many shares you want to
purchase because they trade like stocks.
ETF prices continuously fluctuate throughout
the trading day and you can buy shares
of ETFs whenever the stock market is open.
But before we get into the details,
there are few concepts you need to
know before you buy an ETF.
Passive versus active ETFs.
There are two basic types of ETFs.
Passive ETFs also known as index funds,
simply track a stock index such as the S&P 500.
Active ETFs hire
portfolio managers to invest their money.
The key takeaway,
passive ETFs want to match an index performance,
active ETFs want to beat an index performance.
Expense ratios.
ETFs charge fees known as expense ratios.
You'll see the expense ratio
listed as an annual percentage.
For instance, a one percent expense ratio means that
you'll pay $10 in fees for every $1,000 you invest.
So a lower expense ratio will save you money.
Dividends and DRIPs.
Most ETFs pay dividends.
You can either choose to have your dividends
paid to you in cash or have them
automatically reinvested through
dividend reinvestment plan or DRIP.
Now, let's talk about the taxes in an ETF.
If you buy ETFs in
a standard brokerage account not an IRA,
you should know that could result in taxable income.
Any gains you make from selling
an ETF will be taxed according to
capital gains tax rules and
any dividends you receive will likely be taxable as well.
Of course, if you invest in ETFs through
an IRA you won't have to worry
about capital gains or dividend taxes.
In a traditional IRA,
money in the account is only considered
taxable income after it's withdrawn,
while Roth IRA investments aren't
taxable at all in most cases.
So how much money do you need to be
able to start investing in ETFs?
ETFs don't have minimum investment requirements,
at least not in the same sense that mutual funds do.
However, ETFs trade on a per-share basis
so unless your broker offers the ability
to buy fractional shares of the stock,
you need at least the current price
of one share to get started.
Now let's talk about the pros and cons of ETFs.
The advantages to investing in an ETF.
ETFs provide exposure to a variety of stocks,
bonds, and other assets,
typically at minimal expense.
ETFs take the guesswork out of stock investing.
They allow the investor to match
the market's performance overtime
which historically has been quite strong.
ETFs are more liquid,
easy to buy and sell, than mutual funds.
Online brokers make it easy to buy or sell
ETFs with a simple click of a mouse.
It can be extremely complicated to
invest in individual bonds but
a bond ETF can make
the fixed income portion of your portfolio very easy.
What are some of the drawbacks to ETFs?
Since ETFs own a large assortment of stocks,
they don't quite have
as much return potential as buying individual stocks.
ETFs are often low cost,
but they aren't free.
If you buy a portfolio of individual stocks on your
own you won't have to pay any management fees.
Now let's talk about the steps on how you
should start investing in ETFs.
Let's break those down into three categories.
Open a brokerage account.
Choose your first ETF.
Let your ETF get to work.
Number one, open a brokerage account.
You will need a brokerage account before you
can buy or sell ETFs.
The majority of online brokers offer
commission free stock and ETF trades,
so cost isn't a major consideration.
The best course of action is to look at
each brokers features and platform.
If you're a new investor,
it may be a good idea to choose a broker that
offers an extensive range of educational features.
Number two, choose your first ETF.
For beginner investors,
passive index funds are generally the best way to go.
Passive index funds are cheaper
than their actively managed counterparts.
And the reality is that
most actively managed funds don't
beat their benchmark index over time.
With that in mind, here's the list of
ETFs and a brief description of what
each invests in for beginners
who are just starting to build their portfolios.
Number one, Vanguard S&P 500 ETF,
Schwab US MID-CAP ETF,
Vanguard Russell 2000 ETF,
Schwab International Equity ETF,
Schwab Emerging Markets Equity ETF,
Vanguard High Dividend ETF,
Schwab US REIT ETF,
Schwab US Aggregate Bond ETF,
Vanguard Total World Bond Fund.
You might have noticed that
this list is a little heavy on Vanguard and Schwab,
but for good reason,
both are dedicated to offering Americans
access to the stock market at
minimal expense which is why
their ETFs are among some
of the cheapest in the business.
Step three, let your ETF get to work for you.
It's important to keep in mind that ETFs are
generally designed to be maintenance free investments.
Newer investors tend to have
a bad habit of checking their portfolios far
too often and making
emotional knee-jerk reactions to major market moves.
In fact, the average fund investor
significantly under-performs
the market overtime and over-trading is the main reason.
Once you buy shares of some great ETFs,
the best advice is to leave them
alone and let them do what they are intended to do.
Produce excellent investment growth
over long periods of time.
I hope this video helps you on your investor journey.
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our purpose is to make the world
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