Exchange-traded funds (ETFs) can be great way to invest in the stock market, particularly for those seeking diversification, low costs and flexibility. Whether you’re new to investing or a market veteran, ETFs are a staple among many investors.
Read more: Tools and tips for DIY investing with an Ally Invest Self-Directed Trading account
What are ETFs?
ETFs are funds that pool together the money of many investors to invest in a basket of securities that can include stocks, bonds, commodities and more. That means when you invest in one ETF, you’re exposed to all the underlying securities held by that fund (which can be hundreds).
ETFs are funds that pool together the money of many investors to invest in a basket of securities that can include stocks, bonds, commodities and more.
ETFs are traded like stocks on the stock exchange (hence, the name exchange-traded fund). They’re bought and sold throughout the trading day. That means the price of an ETF share can fluctuate above or below its net asset value (NAV) based on supply and demand.
Investors often incorporate ETFs as part of their overall investment strategy. A long-term ETF strategy, for example, might be a “buy and hold” approach to a diversified ETF. On the short-term, an investor might actively trade ETFs based on market trends.
Developing your ETF investment strategy
If you’re interested in ETFs being a part of your investment strategy, you’ll want to define your goals, understand your risk tolerance and determine asset allocation.
Define your investment goals
Are you socking away for retirement, saving for a splurge in the short-term or collecting cash for a longer-term need, such as college tuition? Defining your investing goals – whether long- or short-term – is important to your ETF investment strategy. For instance, long-term investors with a longer investment time horizon might be better suited to handle the ups and downs of taking on more risk.
Assess your risk tolerance
Knowing what level of risk you’re willing to take on can help you determine your asset allocation – that is, how the assets in your portfolio are allocated to balance risk and reward. Your risk tolerance is determined by several factors including age, net worth and why you’re investing.
Determine asset allocation
Once you know your investment goals and risk tolerance, you can choose your mix of asset classes. While investors with more time and risk appetite often lean into stocks, and those with a shorter timeframe (if they’re closer to retirement, for instance) tend to invest in more conservative securities, such as bonds, consider incorporating both to find balance within your portfolio.
Selecting the right ETFs
If investing in ETFs sounds like a good fit for your portfolio, take the following into consideration.
Research and analyze ETFs
Use online screening tools to find potential funds and then evaluate for specific metrics, including:
Exposure and index: Compare the ETF’s sector, country and stock weightings to its benchmark to ensure it aligns with your objectives
Costs: The expense ratio is the annual fee you pay as a percentage of your investment, so make sure to know what it is and how it compares to similar funds
Performance: While past performance is not a guarantee of future results, you can compare historical returns against benchmark indexes and peers
Diversification strategies
Two of the most common diversification strategies include:
Core-satellite approach: Creating a core portfolio with broad-market ETFs and adding satellite ETFs (small, specialized investments to try to boost returns or target a specific theme) for targeted exposure
Thematic investing: Focusing on specific sectors or trends such as technology or renewable energy
Implementing your ETF portfolio
Get started and stay involved with your portfolio:
Entry strategies: Choose a brokerage account, such as Ally Invest Self-Directed Trading, and fund it.
Monitor and rebalance: Check in regularly with your investments to control risk, maintain your target asset allocation and ensure alignment with your long-term financial goals.
Mistakes to avoid in ETF investing
As with any type investing, be aware of these common mistakes:
Chasing trends: Investing in niche or surging ETFs can often lead to buying at peaks
No clear strategy: Without defined goals, risk tolerance or time horizon, you might end up letting your emotions make decisions
Panic selling: If you sell during market downturns, you might lose more than if you’d stayed invested and let compound interest work
Feel confident in your ETF strategy
Not only do ETFs give you access to stocks that may be too expensive to purchase individually, but they’re also passively managed (often incurring lower fees than their mutual fund companions) and can be bought commission free — making them a less complicated, more affordable alternative for investment novices and pros alike.
