If you follow a lot of personal finance Tik Tok, Instagram, or YouTube Accounts you’ve likely heard the term ETF before. Often touted as the “Smart way to buy into the Stock Market”, ETFs are considered one of the best and easiest ways for beginners to start investing. But why is that? What does ETF even stand for, what are they, and how can they help you get rich? Well, let’s get into it.

What is an ETF?

ETF stands for Exchange Traded Fund, and it is a type of grouped investments that can be traded directly on the stock market. You can think of them like a basket stocks or investments. Instead of having to buy each individual stock or investment, you can just buy a basket (the ETF) and get a portion of each stock relative to price of the basket.

Essentially, an ETF holds a series of underlying assets instead of just one asset. If you have heard of Mutual Funds, they’re very similar with the key difference being these are traded on a stock exchange just like any other stock. So, instead of having to research a bunch different investments and pick them individually, you can invest in an ETF that covers a broad index of industries (like an S&P 500 ETF), or even a specific series of companies in a select industry (like XLK, a Technology Select Sector ETF). ETFs can also be used to track a series of different types of investments; from stocks to bonds to commodities to industries and even cryptocurrency.

The Pros and Cons of ETFs

Starting off with the Pros, one of the best thing an ETF offers is diversification. This benefits you because it lowers your risk to loss by spreading your money around. If you think of your investment being held up by stocks as if they were columns, only buying an individual stock means if the column falls, your investments falls. But if you’re investment is held up by many columns (the underlying stocks of an ETF), then your investment is protected if one stock falls, as depicted in the image below.

ETFs also generally have cheaper Expense Ratios than Mutual Funds, especially when passively managed (we’ll get into that later). An Expense Ratio is the cost you pay for an operator to manage a fund, or in other words to buy all the stocks and investments that go into your ETF Basket. Since passive funds generally take little work to run, they charge less to investors to operate.

Purchasing an ETF is also simpler, more accessible, and less research intensive than purchasing individual stocks, making them great for beginner Investors. If you went the route of buying every stock yourself, you would want to research each company, set up the individual trades for each stock yourself and then have to manage when you should sell certain portions off based off the drop in market cap. Also, if you planned to buy all the stock individually, you would need substantial capital to purchase stock in all 500 companies in the S&P 500 for example. To demonstrate, let’s say you wanted to buy just one share of only Apple ($169.36/share), Meta ($178.57/share), and Amazon ($141.87/share). At the time of writing this, that would cost you $489.80 for just those 3 stocks. On the other hand, you could invest in an S&P 500 Index ETF, like VOO, that would only cost you $388.35 and you would be invested in those companies as well as the rest of the S&P 500. $388.35 is substantial more manageable than buying all 500 companies individually.

Lastly, ETFs can be traded during any time while the market is open. Mutual funds are usually only sold at the end of the business day, which makes it harder to buy in at a specific price. It can also be traded like any other stock. With Mutual funds, you may not be able to invest in a particular fund unless you utilized the brokerage that operates that fund. For example Fidelity’s ZERO Total Market Fund is one of the rare Mutual Funds that has a 0% expense ratio. However, you can’t purchase that fund unless you utilize Fidelity as your brokerage.

Now for the Cons, I’m going to contradict myself a bit. As I mentioned, passively managed funds have cheaper Expense Ratios, actively managed funds can have high Expense Ratios. For an example, the actively managed ETF that matches the Hedge Funds portfolio of ARK Innovations (ARKK) has an expense ratio of 0.75% which is on the higher end. This is common with actively managed funds.

Another counter is since some ETFs can focus on just a specific industry you could lack diversification due to limit of a single industry. So let’s say you buy an industry exclusive ETF that only focuses on Silver Mining Companies and the cost of Silver drops, you would assume all the companies in your ETF would also fall so you aren’t mitigating your risk.

PROS

• Offer Diversification to Reduce Risk

• Cheaper Expense Ratio for Passive Funds

• Simple, Accessible, and Require Less Research

• Traded Anytime During Market Hours like any other Stock

CONS

• Actively Managed Funds can have Higher Expense Ratios

• Single Industry or Commodity ETFs Lack Diversification

Passive vs Active ETFs

Told you I would get into it later… Passive ETFs are essentially ones that take little to no human effort to manage. The general object of these funds is to match a broad index or sector, such as an ETF that matches the S&P 500. Since these funds just duplicate these indexes, they can be simply managed and don’t require decisions to be made by the operator of the ETF.

Active ETFs are funds managed by portfolio managers who make decisions about which securities to include or not include at different times. Since they don’t match an index, these funds require that choices be made as the market changes. This is why they can be more expensive and take a lot of work. The cost of that work is also passed on to you as a buyer.

How ETFs can make you Rich!

As simple and boring as ETFs may sound, they can absolutely make you rich over the long term. As mentioned many times above, passive S&P 500 Index ETFs are cheap, easily traded, and offer great diversity. All the benefits of a great investment portfolio. Also, on average, the S&P 500’s historic annualized return is 10.5%. At that rate, if you invested just $5,000 a year, you would have $1,000,000 in a little over 30 years. Those are substantial returns which are surprisingly hard to beat with an active fund. If you don’t believe me though, maybe you’ll believe Warren Buffett.

For those that don’t know Warren Buffett, the Oracle of Omaha, is touted as one of, if not the, most successful investor of the 20th Century. Now in 2008, Mr. Buffett proposed a million dollar wager to the hedge funds that a boring S&P 500 Index Fund would beat their actively managed funds over the long term. The hedge fund Protégé took that bet and they lost bad! The co-founder surrendered defeat in 2016, at which point the Protégé Fund returned 2.2% year, while Buffett’s Index Fund returned 7.1% per year! To put that another way, Buffet made $854,000 and the Protégé Fund made only $220,000. That’s a $634,000 difference proving the “exorbitant” fees of hedge funds actively managed portfolio weren’t worth it.

How can you Invest in ETFs?

Investing in ETFs is as simple as investing in any other stock, with some slight details. Just follow these steps;

1) Research ETFs

You have to research ETFs just like you would any stock. The things you’ll want to consider are;

• Companies Included - What type of ETF is it? Does it match an Index like the S&P 500 or a specific sector or commodity

• Price - Is the price of the ETF one you can afford? ETFs will vary with the market and trying to time the market over the long term is generally very hard to do (just look back at the Buffett Bet)

• Expense Ratio - How much does it cost to own the ETF? If possible, look for lower Expense Ratios around 0.03% to 0.05%. This is common with many Index ETFs

2) Open a Brokerage Account

If you don’t have a brokerage account to invest with already, there are many out their you can start with and researching which is best for you is important. Today, many brokerages offer low to zero commission fees so that will be ideal. If your interested in joining one now, I personally use E*Trade and WeBull for my non-retirement investing. You can sign up for either now with the links below;

• Click this link for E*Trade and could get rewarded with up to $3,500 once you open an account and make a qualifying deposit. Reward amount depends on how much you deposit.

• Click this link WeBull and you can earn up to 5 free stocks when you open and fund your account

3) Purchase your Researched ETFs

Now that you’ve done your research and opened a brokerage, you’re ready to buy your ETFs! Simply search the ETFs in your brokerage and place an order to buy. Some ETFs I personally own are;

• VTI - Vanguard Total Stock Market Index

• VOO - Vanguard S&P 500 Index

• QQQ - Invesco NASDAQ 100 Index

• VYM - Vanguard High Dividend Yield ETF

The Wrap-Up

As a reminder, I’m not a certified Financial Planner nor should this be construed as anything more than education. If you’re interested in investing in ETFs, you should research your own ETFs and not just follow whatever advice you find. The big things you can take away from here though are;

• ETFs are baskets of Investments that can be bought and sold just like a Stock

• They provide Simple and Accessible Diversification

• Diversification helps protect your portfolio by reducing risk to your overall investment

• Passive ETFs generally have cheaper Expense Ratios than Active ETFs or Mutual Funds

• The S&P 500 has returned a historical annualized average of 10.5% since Inception and there are ETFs that Match it

ETFs can be a great way for beginner investors to start investing safely. Now, that doesn’t mean you shouldn’t invest in individual stocks if you so choose. However, experts generally recommend diversifying your portfolio and ETFs are an easy way to hedge. No matter what, Financial Literacy is the Number 1 Key to Financial Success, so keep learning!

Links

If you’re interested in opening an IRA with E*Trade, click this link (→E*Trade←) and you will get rewarded with up to $3,500 once you open an account and make a qualifying deposit! Reward amount depends on how much you deposit.

If you’re interested in opening an IRA with WeBull, click this link (→WeBull←) and you can earn up to 5 free stocks when you open and fund your account!

*Disclosure* This is NOT financial advice and I am NOT a Certified Financial Planner. All information is provided for educational purposes only and is not to be construed as advice. Everyone’s financial situation is different and requires individualized planning. Seek out a Certified Financial Planner for assistance with your own financial situation.

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