For some people, researching stocks and buying shares of individual companies is fun-- and it can also be very profitable. But for others, figuring out what stocks to buy is confusing, and putting in the time researching companies just isn't going to happen.
If you don't want to be an active investor or aren't sure how to start when it comes to picking out individual stocks, you may want to opt for a simpler alternative instead: an Exchange Traded Fund, or ETF.
What is an ETF?
ETFs are baskets of investments that give you exposure to particular asset classes (groups of investments with shared characteristics). When you invest in an ETF, you make one purchase but end up invested in everything the fund owns, including stocks, bonds, or commodities.
ETFs are sold on stock exchanges and you can buy trade them throughout the day. If your broker offers fractional shares, then you may be able to buy partial shares of ETFs as well as individual stocks.
Most ETFs are passively managed (there's no fund manager personally selecting stocks) and they track the performance of financial indexes, such as the S&P 500 index. However, some ETFs do have managers, and there are also ETFs that use specific kinds of investing strategies beyond just buying every stock on an index.
Why is an ETF an ideal option if you don't know what stocks to buy?
If you aren't sure what individual stocks to buy, ETFs make picking investments much easier.
You could, for example, opt for an ETF that tracks the performance of the stock market, such as the Vanguard S&P 500 (NYSEMKT:VOO) or the Vanguard Total Stock Market (NYSEMKT:VTI). Both provide an easy way to diversify, with the S&P fund spreading your money around the 500 largest publicly traded U.S. companies while the Total Stock Market fund provides exposure to all investable U.S. securities including small and mid-sized companies too. Since you're basically investing in a little of everything with these funds, you're limiting your risk and should see reasonable returns over time since the market as a whole usually averages around a 10% annual return.
But you don't have to limit yourself to ETFs that track the performance of the market as a whole. There are also ETFs dedicated to specific industries, or thematic ETFs that give you exposure to companies or sectors within a particular niche.
For example, if you think the marijuana industry has a ton of room to grow as the laws surrounding cannabis are relaxed, you may want to invest in marijuana stocks -- but might not be sure how to pick stocks of individual companies in the industry. You could instead choose a marijuana ETF such as ETFMG Alternative Harvest (NYSEMKT:MJ) that gives you broad exposure to a bunch of different marijuana-related businesses including growers, distributors, and those researching medical uses for marijuana. You'd be investing in marijuana and would do well if the industry expands as you expect, without having to take a ton of time to pick which specific cannabis-related businesses you think are best poised for gains.
Similarly, if you want to invest in companies that produce medical devices, there are ETFs for that too, including the iShares U.S. Medical Devices ETF (NYSEMKT:IHI). And there are ETFs for pet products for people who think Americans will spend more on their pets as they have fewer children; or for gold and silver investments for people worried about the currency being devalued. In fact, there's an ETF for almost anything you can think of.
While opting for ETFs that track the performance of the market as a whole can be the safest way to go, purchasing industry-specific or thematic ETFs is a good way to dip your toe into picking investments you think could outperform the market. You'd be taking on more risk by investing in an ETF exposing you to a specific industry since it's more likely for that one industry to underperform over time, rather than every industry if you're investing in the market as a whole. But since you're spreading your money around among a bunch of companies, you're taking less risk than if you bet it all on a few specific businesses by buying shares of them.
Of course, on the flip side, you do have less of a chance of eye-popping gains with an ETF than if you're picking individual stocks. After all, it's more likely that one particular company you invest in will see explosive growth and substantially outperform the market, compared with an entire industry. But if your hope is to find that one company that turns into the next Amazon (NASDAQ:AMZN) or Netflix (NASDAQ:NFLX), you'll need a lot more stock-picking acumen (and a lot more time to research businesses) than it takes to just buy an ETF.
Of course, you'll still want to have a strategy for how to pick ETFs so you understand the fundamentals to look for. But you'll probably find picking ETFs simpler than figuring out how to pick stocks. It's just a matter of how much time you want to spend researching investments, and whether you're willing to do the extra work involved.
Is investing in an ETF right for you?
The bottom line is, investing in ETFs is a good way to build a diversified portfolio and set yourself up to make money investing in the stock market. You may not do as well as you could if you aim to beat the market through researching stocks and building a customized portfolio -- but if spending a lot of time figuring out what stocks to buy doesn't sound like fun, ETFs may just be the best choice for you.