As someone who didn't grow up with financially savvy parents or financial mentors, I saw investing as something reserved for people who had lots of money, or who were very knowledgeable about how the stock market works. I thought it required spending tons of time researching companies, looking through financial statements, and being glued to investing programs on CNBC.
However, my assumptions couldn't be further from the truth. By no means are any of those activities required to be a good investor. In fact, they can be counterproductive when they cause you to chase "the next big thing," second-guess yourself, or just succumb to information overload.
One thing I wish I had known before buying my first stock is how efficient investing in exchange-traded funds (ETFs) can be, and how much effort it removes.
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What exactly are ETFs?
An ETF is a collection of different stocks packaged together into one fund, allowing you to instantly invest in all of the companies at once. Think about it like this: Instead of going to a grocery store and picking out individual items to put into your basket, you can buy the basket already prefilled, saving you time and effort.
In many cases, an ETF is weighted by market cap, so larger companies in the ETF will receive more of your investment than smaller ones. For example, if Company A accounts for 10% of an ETF, and Company B accounts for 1%, investing $1,000 in the ETF would mean $100 going into Company A's shares, and $10 going into Company B's.
What are the advantages of investing in ETFs?
The main advantage of investing in ETFs is that you get instant diversification, generally with a single investment. Instead of investing in dozens (or even hundreds) of individual companies to achieve diversification, you could invest in just one ETF that accomplishes all that for you. This saves time and effort.
Investing in ETFs also reduces the risks that come with investing in individual companies. The stock market is notoriously irrational; all it takes is a negative headline (justified or not) or unmet short-term expectations for a company's shares to drop.
In an ETF, even with one stock (or a few stocks) down, you have others that can pick up the slack and help balance things out. ETFs aren't immune to volatility, but they're often much steadier than an individual stock.
What ETF makes a good first investment?
There are thousands of ETFs to choose from, but one that stands out for first-time investors is an S&P 500 ETF like the Vanguard S&P 500 ETF (VOO 0.51%). When you invest in this ETF, you get instant exposure to around 500 of the largest and most influential companies in America. Notable names in the ETF include Apple, Coca-Cola, Johnson & Johnson, JPMorgan Chase, Walmart, and plenty of other household names.
The Vanguard S&P 500 ETF has become concentrated in tech stocks (34.8% of the ETF) due to the significant increase in their valuations in recent years, but it still contains companies from all major sectors. You'll have access to companies in the healthcare, energy, consumer discretionary, industrial, real estate, and other sectors of the economy.
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It's not just me who's a fan of investing in the S&P 500, either. Famed investor Warren Buffett has said for decades that consistently investing in an S&P 500 ETF makes the most sense for the average investor. And the best way to do so is through dollar-cost averaging.
When you dollar-cost average, you set a specific amount and a specific time to make investments, and follow your schedule regardless of what stock prices are at that time. It could be investing $100 every Monday, investing $250 every other Friday, investing $500 at the beginning of each month, or whatever makes the most sense for your financial situation.
You'll buy fewer shares when prices are higher, and more when they're lower. What matters most is that you remain consistent and trust that the process will pay off long-term -- which it typically does.
