For new investors, it can be challenging to research and invest in single companies. Luckily, that's where exchange-traded funds (ETFs) come into play. ETFs allow investors to invest in multiple assets with a single investment. Different ETFs are created based on different criteria, like sector, company size, or company mission.
If you're new to investing, you can rarely go wrong with first looking into the S&P 500, which tracks the 500 largest publicly traded American companies. That's why the Vanguard S&P 500 Index Fund ETF (VOO 0.58%) is my No. 1 recommendation for new investors.
You can achieve instant diversification
One of the pillars of a good investment portfolio is diversification. The adage, "don't put all your eggs in one basket" applies to many aspects of life, and investing is one of them. As an investor, you never want your portfolio's success (or downturn) to rely on too few investments; you want your risk spread out. With the Vanguard 500 Index Fund ETF, investors can achieve instant diversification with a single investment.
The ETF consists of 506 large-cap companies spanning any industry you could imagine. The top five industries represented in the fund are:
- Technology (28%)
- Health care (13.6%)
- Consumer discretionary (12%)
- Financials (11.1%)
- Communication services (9.4%)
Although majority of the fund is made up of the top five industries, it also includes companies from real estate, energy, industrials, and utilities. For new investors, getting access to these industries with a single purchase is much more efficient than learning each respective sector and finding individual companies within it to invest in.
It pays out dividends
Outside of an increase in a stock's price, dividends are the other primary way to make money from an investment. It's a way for companies to reward shareholders for holding onto their shares. As of May 2, the Vanguard S&P 500 ETF had a dividend yield of 1.46%. And while this percentage may seem small, it can make a big difference over time compared to an ETF that doesn't pay out dividends.
Let's assume an ETF returns 8% annually, a bit below the historical annual return of the S&P 500. If you were to contribute $500 monthly into the ETF, you would have accumulated over $679,000 in 30 years. If you did the same thing and incorporated a 1.46% dividend yield, this total would increase to over $891,000. With no more effort or work involved on the investor's behalf, a "simple" dividend can be worth over $200,000 in the long run.
It's cheap to own
ETFs come with an expense ratio, which is charged as a percentage of your total invested amount. If the expense ratio is 0.5%, you'll be charged $5 for every $1,000 you have invested. While the S&P 500 is a universal index, different financial companies put together their own respective S&P 500 ETFs and may have different expense ratios.
At 0.03%, Vanguard's S&P 500 ETF is one of the cheaper ETFs you'll run into. Yes, free is best, but only paying $0.30 per $1,000 you have invested is a steal. Much like a relatively small dividend yield can add up to thousands over time, the smallest differences between expense ratios can add up to sizable amounts in the long term.
The most important thing is starting
If you're new to investing, the best thing you can do is start. A lot of the value in investing comes from compound interest, which takes time. The earlier you begin investing, the better -- and it doesn't have to be complicated. Consistently investing in an S&P 500 fund can work wonders and put you in a position to flourish financially by the time you retire.