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Why Index ETFs Are a New Investor's Best Friend

By Katie Brockman – May 24, 2020 at 9:00AM

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New to the stock market? These steady funds are you're best option

Investing in the stock market can be daunting, particularly if you're a beginner. Especially right now, when the stock market recently closed out one of its worst first quarters in history due to the coronavirus pandemic, it can be intimidating to figure out where to begin.

However, although the stock market will always have its ups and downs, investing is one of best ways to build wealth -- and there's never been a better time to get started. Stock prices are at their lowest during market downturns, meaning you can get more for your money by investing now. It's important to invest wisely, though, because putting your money in the wrong places could be a costly mistake.

Fortunately, there are plenty of beginner-friendly investment choices out there, and index ETFs are among the best of the best.

Figurines of bear and bull

Image source: Getty Images.

What are index ETFs?

Index ETFs (exchange-traded funds) are collections of stocks designed to replicate a particular index, such as the S&P 500 or Dow Jones Industrial Average. When you invest in an index ETF, you're actually investing in dozens of or even hundreds of different stocks, bonds, and other securities at once. This creates instant diversification, which can significantly limit your risk because even when a handful of stocks in the fund aren't performing well, it won't sink the overall value of the fund.

Diversification is one of the biggest advantages of index ETFs, making these funds perfect for beginners. Timing the market correctly is extremely difficult (even for the experts), and choosing individual stocks to invest in requires loads of research. With index ETFs, however, you can invest in hundreds of stocks at once without having to worry about how each individual stock in the fund is performing.

The other major benefit with index ETFs is that they are passive investments -- meaning once you start investing, you can essentially "invest it and forget it." You don't need to try to time the market or worry about when to sell. Rather, you can take a hands-off approach and let your investments take care of themselves. Index ETFs are slow but steady, so while you likely won't see dramatic short-term gains, if you leave your money alone long enough, your investments will grow significantly over time.

Another benefit of passive investments is that you'll typically pay lower fees than if you invest in actively managed mutual funds. Mutual funds are also large collections of stocks and bonds, but they're overseen by a portfolio manager who chooses which investments to include in the fund. Because there's a person managing the investments in the fund, actively managed mutual funds are typically more expensive than passive investments like index ETFs.

How to get started investing in index ETFs

There are countless index ETFs to choose from, so you have plenty of options. Many index ETFs also trade for a fraction of the price of the underlying index, making them a great choice for beginners who are just getting their feet wet and don't want to invest a lot of money right now.

One of the best places to start is by investing in an index ETF that tracks the S&P 500. The S&P 500 encompasses 500 of the largest U.S. companies across various industries, and it's generally considered one of the best representations of the U.S. stock market. There are several index ETFs that track the S&P 500, including Vanguard S&P 500 ETF (VOO), SPDR S&P 500 ETF Trust (SPY), Schwab S&P 500 Index Fund (SWPPX), and iShares Core S&P 500 ETF (IVV).

No matter where you choose to invest, there will still be some risk. If the stock market as a whole takes a turn for the worse, your index ETFs likely will as well. But in general, index ETFs are much less risky than holding individual stocks.

Getting started investing in the stock market can be intimidating, but it doesn't have to be. Index ETFs are a great investment choice whether you're a beginner or have been investing for years, and they're a smart option to limit your risk while maximizing your rewards.

Katie Brockman has no position in any of the stocks mentioned. The Motley Fool owns shares of Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Vanguard Index Funds - Vanguard S&P 500 ETF Stock Quote
Vanguard Index Funds - Vanguard S&P 500 ETF
VOO
$328.30 (-1.52%) $-5.08
SPDR S&P 500 ETF Trust Stock Quote
SPDR S&P 500 ETF Trust
SPY
$357.18 (-1.55%) $-5.61
iShares S&P 500 ETF Stock Quote
iShares S&P 500 ETF
IVV
$358.65 (-1.57%) $-5.72
Schwab Capital Trust - Schwab S&P 500 Index Fund Stock Quote
Schwab Capital Trust - Schwab S&P 500 Index Fund
SWPPX
$56.37 (-210.10%) $-1.21

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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