Exchange-traded funds have gotten a huge amount of attention from the investing community in recent years. But with all the talk about how short-term strategies using hot ETFs will supposedly make you rich before you know it, you might well think that ETFs are only for sophisticated traders with the know-how to jump in and out of stocks at a moment's notice.
Nothing could be further from the truth. Even beginning investors can use ETFs to build a portfolio that will last a lifetime -- and lately, it's gotten easier than ever to get started.
Keeping your cool
When you start looking at the ETF universe, you'll certainly find plenty of ETFs that are designed for use by short-term traders. In particular, leveraged ETFs are designed to track daily returns of the indexes they track. For instance, with the ongoing debate about whether banks can recover from their excesses during the housing boom and adopt new and viable business models going forward, bulls use ProShares Ultra Financials (NYSE: UYG ) to double their potential gains, while bears use Direxion Daily Financial Bear 3x (NYSE: FAZ ) to multiply their profits when financial stocks fall. But anyone who has stayed in those ETFs over a matter of years has suffered huge losses, regardless of which side of the argument they were on.
As a long-term investor, though, you don't have to worry about that sort of ETF. Instead, focus on some simple strategies designed to make the most of the simplicity and cost-effectiveness of ETFs.
1. Build an ETF core for free.
One big obstacle to beginners using ETFs is that you had to pay a brokerage commission to buy them. So if you only had $100 to invest in a particular month, even a relatively modest commission of $10 was way too much to pay to buy ETF shares.
Thanks to competition in the ETF industry, though, you can now buy some ETFs without paying any commission at all. Fidelity, Vanguard, and Charles Schwab all have arrangements giving their brokerage customers free access to extensive lines of ETFs that span a wide range of investment types. From the broad-market U.S. stock ETFs Vanguard Total Stock Market (NYSE: VTI ) and iShares S&P 500 to niche investments like iShares MSCI Emerging Markets (NYSE: EEM ) or Schwab International Small-Cap ETF, it's easy to build an asset allocation-based strategy that fits your needs and goals.
2. Invest in your best ideas without losing your shirt.
Often, you'll have ideas about what type of business you want to invest in, but deciding which individual stock to pick may be tricky. ETFs can make it easier to get all the stocks you want.
For instance, in the telecommunication industry, you'll find lots of stocks paying amazingly attractive dividends that appear to be sustainable for the long haul. If you only have enough money to buy one or two positions, you might feel obliged to stick with the best known names like AT&T and Verizon.
But the better choice may be a sector ETF that includes not only the stalwarts in an industry but also smaller players with even better prospects. The iShares Dow Jones US Telecom ETF would give you exposure to the smaller telecoms CenturyLink (NYSE: CTL ) and Windstream (Nasdaq: WIN ) , which have even more attractive dividends than AT&T and Verizon. Moreover, by holding an ETF, you have much more protection against a stock-specific problem that could pummel a particular company in the sector.
3. Get access to alternative investments.
Buying stocks is easy. But after the bear market, there's been a lot more interest in alternatives like precious metals, commodities, and foreign exchange. Investing in those areas used to be very difficult, but with ETFs, it's now easier than ever to get started.
For example, gold recently broke out of a trading range to hit fresh new record highs of $1,275 per ounce. If you go to a coin dealer to buy gold bullion, though, you may pay a premium of $50 per ounce or more above the current price.
However, investors can get gold price exposure through ETFs just as easily as they can buy a stock. Each share of the SPDR Gold Trust (NYSE: GLD ) , for example, is worth roughly a tenth of an ounce of gold. ETFs for other precious metals have similar characteristics.
Make investing easier
ETFs have become so popular because they're so easy to use. With any of these strategies, even beginners can make a great start to their investing career using ETFs without feeling like they need to become professional traders to use them.
Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance.