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Exchange-traded funds (ETFs) are an easy way to begin investing. They are fairly simple to understand and can generate impressive returns with minimal expense and effort. They are also easy to buy and sell. Here's what you should know about ETFs, how they work, and how to invest in them.
An ETF allows investors to buy many stocks or bonds at once. People buy shares of ETFs, and the money is invested according to a certain objective.
For example, if you buy an S&P 500 ETF, your money will be invested in the 500 companies in that index. As a result, your investment's performance should roughly match that of the index over time.
One common question is how ETFs differ from mutual funds since the basic principle is the same. The key differences between these two types of investment vehicles have to do with how you buy and sell them.
Before we get any further, there are a few concepts that are important to know before you buy your first ETFs.
Think of ETFs as having some features of stocks and some features of mutual funds.
ETFs trade just like stocks on major exchanges like the New York Stock Exchange (NYSE) and Nasdaq. They have a share price that fluctuates throughout the trading day, and investors buy a certain number of shares.
Like mutual funds, ETFs are designed to pool investors' money together to invest for a common purpose. For example, an S&P 500 ETF would allocate the fund's money proportionally to the 500 companies that make up the popular benchmark index.
If you buy ETFs in a standard brokerage account (i.e., not a retirement account), you should know that they could result in taxable income. Any gains you make from selling an ETF will be taxed according to capital gains tax rules, and any dividends you receive will likely be taxable as well.
Of course, if you invest in ETFs through an individual retirement account (IRA), you won't have to worry about capital gains or dividend taxes. In a traditional IRA, money in the account is considered taxable income only after it is withdrawn, while Roth IRA investments aren't taxable at all in most cases.
ETFs don't have minimum investment requirements -- at least not in the same sense that mutual funds do. However, ETFs trade on a per-share basis. Unless your broker offers the ability to buy fractional shares of stock, you'll need at least the current price of one share to get started.
Let's look at some pros and cons of investing in ETFs.
There are literally thousands of ETFs available to invest in right now. In fact, the number of ETFs recently surpassed the number of publicly traded stocks for the first time ever. So, how do you find the right ETFs for you?
Here are some of the things to consider:
It's important to keep in mind that ETFs are generally designed to be maintenance-free investments. Newer investors tend to have a bad habit of checking their portfolios far too often and making emotional, knee-jerk reactions to major market moves.
In fact, the average fund investor significantly underperforms the market over time, and overtrading is the main reason.
So, once you buy shares of some great ETFs, the best plan is to leave them alone and let them do what they're intended to do: produce excellent investment growth over long periods of time.
Company name | Current price |
---|---|
Vanguard S&P 500 ETF | $613.97 |
Schwab Strategic Trust - Schwab U.s. Mid-Cap ETF | $29.57 |
Vanguard Russell 2000 ETF | $98.31 |
Schwab Strategic Trust - Schwab International Equity ETF | $23.66 |
Schwab Strategic Trust - Schwab Emerging Markets Equity ETF | $33.57 |
Vanguard Whitehall Funds - Vanguard High Dividend Yield ETF | $140.58 |
Schwab Strategic Trust - Schwab U.s. REIT ETF | $21.76 |
Schwab Strategic Trust - Schwab U.s. Aggregate Bond ETF | $23.70 |
Vanguard Scottsdale Funds - Vanguard Total World Bond ETF | $70.31 |
Invesco QQQ Trust | $605.20 |
You might notice that this list is heavy on Vanguard and Schwab. There's a good reason: Both are dedicated to offering easy access to the stock market at a minimal expense, so ETFs from both tend to be among the cheapest in the business.