When you're just starting to invest, it's easy to get overwhelmed by the sheer number of options. Instead of rushing in and buying something you don't understand, purchasing an exchange-traded fund (ETF) is an excellent first move. ETFs are similar to mutual funds, except they trade like a stock.
There are thousands of these ETFs, each centered around a different theme. Some good ones to start with are the Vanguard Total Stock Market ETF (VTI -0.79%), the Vanguard S&P 500 ETF (VOO -0.84%), and the Vanguard Russell 2000 ETF (VTWO 0.17%). These are basic but important in every investor's portfolio. Here's why all investors (even experienced ones) should consider these three ETFs.
The basis of all portfolios should include these indexes
The Total Stock Market ETF centers around all stocks traded in the U.S. This includes small and micro-cap stocks that the Vanguard 500 (which tracks the S&P 500) misses. As a result, the index has captured the rise of companies like Amazon, Netflix, and Tesla, where the S&P 500 didn't. However, capturing these rises doesn't always mean outperformance.
Data by YCharts.
While these two closely track each other, there are different time periods where one might outperform the other. Because of that, purchasing both in equal amounts is a great idea.
Another reason these two should be your first purchase is the instant diversification it provides. You're purchasing thousands (Total Stock Market) plus 500 (Vanguard 500) companies spread across multiple sectors with both indexes. This prevents being over-exposed to one sector, which might occur when you first begin.
Lastly, purchasing these indexes isn't settling. This was a common misconception I had when I first began investing, but sometimes matching the market is a wise investment strategy. Warren Buffett believes most investors would succeed by purchasing a low-cost index fund like these two. In fact, when he passes away, 90% of his estate will be invested in one of these funds.
Both of these ETFs would make great purchases, but there are other funds out there.
Other ETFs are more specialized
The Vanguard Russell 2000 Index gets a bit more exploratory, as it tracks the Russell 2000 index. The stocks in this index are the smallest 2,000 of the largest 3,000 companies listed in the U.S.
Small-cap stocks produce some massive winners and usually outperform large caps (over long time horizons). However, since 2021, small caps have had a pretty bad run.
Data by YCharts.
With small caps underperforming recently, a turnaround might be imminent. Plus, small-cap stocks tend to outperform during the recovery following a bear market. Considering that's where we may find ourselves right now, small-cap stocks look attractive.
With all three of these ETFs, there is one other consideration: the expense ratio. This number tells investors how much a company like Vanguard charges for managing your money. For this trio, the expense ratio is very attractive.
| Fund | Expense Ratio |
|---|---|
| Vanguard Total Stock Market ETF | 0.03% |
| Vanguard S&P 500 ETF | 0.03% |
| Vanguard Russell 2000 ETF | 0.10% |
Data source: Vanguard.
For every $1,000 you invest in the Vanguard Total Stock Market or Vanguard S&P 500 ETFs, Vanguard will charge you $0.30 annually. That's practically nothing. As a general rule of thumb, the less mainstream an ETF gets, the higher the expense ratio, which is why the Vanguard Russell 2000 ETF charges $1 for every $1,000.
Still, that's not a lot of gains to give up, especially since you don't have to do any work besides purchasing the ETF.
There are thousands of other ETFs allowing you to focus on any sector or strategy, but these three are solid bedrock funds to build a portfolio on. If I were to start over my portfolio from scratch, these three would be among my first purchases.
