We know the world of investing can be intimidating. The abundance of acronyms and bounty of buzzwords is a lot to take on alone — then you have to make sense of it all, strategize, invest, sell, and more? It’s enough to make you say, “I’ll buy one stock in Berkshire Hathaway, one in Amazon, and call it a day.” That is, until you realize those stocks can cost upwards of four to six figures.
Fortunately, investing doesn’t have to be overly complicated (or expensive). Whether you’re new to investing or a market veteran, you can build a portfolio (and even get a piece of the Berkshire Hathaway pie) with exchange-traded funds (ETFs).
These funds are the favorites of many investors because of their ability to diversify a portfolio, their liquidity, range of asset classes, low expense ratios … Okay, enough with the investing lingo. Let’s take a deeper look into ETFs, why you might want to invest in them, and how you can select between various ETF portfolio strategies to land on one that best suits your investment goals.
ETFs are similar to mutual funds in that they pool together money from multiple investors to purchase a basket of securities. Those securities may include a combination of stocks, bonds, commodities, and/or other investment types. ETF securities usually track a particular index, like the S&P 500, or a specific industry, like energy or technology.
What sets ETFs apart from mutual funds is how they’re bought and sold. ETFs are traded on an exchange throughout the day like stocks, and their prices fluctuate based on market demand. (Mutual funds are only traded once per day after the market closes.) Because of this, ETFs are considered more liquid than mutual funds.
You can receive returns in a couple of ways with ETFs. Investors can earn returns when the prices of the securities within the ETF rise, similar to individual stocks. Investors may also benefit from dividends, or a portion of earnings companies pay their investors for owning the stock. Typically, dividends are paid to shareholders on a quarterly basis.
The cost of ETF investing
ETFs are typically passively managed (compared to say, actively managed mutual funds). This means that instead of a fund manager using their knowledge to select the investments in the ETF, they simply select securities to try and keep pace with a major benchmark, like the Dow Jones Industrial Average or the Russell 2000.
Since they’re less time-intensive for brokerages, ETFs come with a big upshot for you: lower expense ratios (a.k.a. the cost for operating and managing a fund) than many other investment options.
Even better, when you invest in ETFs, you’re able to invest in hundreds or even thousands of securities with just one transaction. Not only does this allow ETF investors to hold portions of stocks they might not be able to afford otherwise (like Berkshire Hathaway), it can also mean commission-free trading. Whether you’re a D.I.Y investor or prefer to enlist the expertise of our robo advisor, we offer you the ability to buy and sell ETFs at no cost.
Build an ETF investment strategy
Now that you understand the basics of ETFs, you can explore your ETF options and create a strategy to add these investments into your portfolio.
What really makes ETFs a popular investment option is the ability to diversify. Portfolio diversification is an important investment strategy that helps you better manage the risk of market volatility. Since ETFs are comprised of numerous holdings (sometimes spanning industries) within a single fund, the negative effects of any up and down swings in the market are typically less severe.
You can achieve diversification by investing across asset classes, industries, and countries. In an ETF portfolio, for example, you could consider investing in multiple unrelated Sector ETFs (those that track industries), like Energy and Health Care. That way, the ETFs’ holdings largely differ and will be less likely to be affected by the same market influences.
You can also add diversification by choosing funds with holdings in different asset classes. For example, you could invest in a government bond ETF, a precious metal-tracking commodity ETF, and a foreign currency ETF.
When you’re ready to invest in ETFs, begin by defining your investment goals: Are you socking away for retirement, saving for a splurge in the short-term, or collecting cash for college tuition? Long-term investors with a larger investment time horizon can typically take on more risk.
You’ll also want to consider your current income needs. If you’re hoping to bring in a steady stream of returns, you might want to add a mix of dividend-paying or fixed-income ETFs to your portfolio.
Having a solid idea of these factors, as well as your risk tolerance, will help you determine your asset allocation — an investment strategy that aims to eliminate risk in your portfolio by investing across different asset classes. This helps maintain a balance between risk and reward. You may find you’re comfortable investing more heavily in bonds (often a lower-risk investment) than stocks, for example.
Nervous to enter the ETF market? Our Managed Portfolio has a 30% cash buffer that will help protect you against potential risk.
Interested in investing in companies that practice sustainability and other planet-friendly initiatives? You can create a portfolio of ETFs that invests in socially-responsible businesses.
And if you’re looking to reduce the amount of taxes you owe, you can build an ETF portfolio that’s optimized for returns while lowering your tax bill.
Even if you’re more D.I.Y. when it comes to investing, ETFs can have a place in your investment strategy. Our Self-Directed Trading platform gives you the ability to buy and sell ETFs with ease.
You may even decide you’re interested in building an all-ETF portfolio. Keep in mind, even though an ETF itself is inherently diverse in nature, you’ll still need to diversify your entire portfolio. If you only own one ETF, all your eggs will be in a single investing basket.
Exchange-traded funds are a great way to take some of the complication and confusion out of investing. Not only do they give you access to stocks that may be too expensive to purchase individually, they’re also passively managed (often incuring lower fees than their mutual fund companions) and can be bought commission free — making them a less complicated, more affordable option for investment novices and pros alike.