This ETF Could Help Grow Any Retirement Account
Here's why it pays to add it to your portfolio.
Exchange-traded funds, or ETFs, are an easy way to begin investing. ETFs are fairly simple to understand and can generate impressive returns without much expense or effort. Here’s what you should know about ETFs, how they work, and how to buy them.
An exchange-traded fund, or ETF, allows investors to buy many stocks or bonds at once. Investors buy shares of ETFs, and the money is used to invest 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.
One common question is how ETFs differ from mutual funds since the basic principle is the same.
The key difference between these two types of investment vehicles is how you buy and sell them. Mutual funds are priced once per day, and you typically invest a set dollar amount. Mutual funds can be purchased through a brokerage or directly from the issuer, but the key point is that the transaction is not instantaneous.
On the other hand, ETFs trade just like stocks on major exchanges such as the NYSE and Nasdaq. Instead of investing a set dollar amount, you choose how many shares you want to purchase. Because they trade like stocks, ETF prices continuously fluctuate throughout the trading day, and you can buy shares of ETFs whenever the stock market is open.
Before we get any further, there are a few concepts that are important to know before you buy your first ETFs.
If you buy ETFs in a standard brokerage account (not an IRA), 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 IRA, you won't have to worry about capital gains or dividend taxes. In a traditional IRA, money in the account is only considered taxable income after it is withdrawn, while Roth IRA investments aren't taxable at all in most cases.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, so 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.
You’ll need a brokerage account before you can buy or sell ETFs. The majority of online brokers now offer commission-free stock and ETF trades, so cost isn’t a major consideration. The best course of action is to compare each broker’s features and platform. If you’re a new investor, it might be a good idea to choose a broker that offers an extensive range of educational features, such as TD Ameritrade (NASDAQ:AMTD), E*Trade (NASDAQ:ETFC), or Schwab (NYSE:SCHW), but there are several other excellent brokers to choose from.
For beginners, passive index funds are generally the best way to go. Index funds are cheaper than their actively managed counterparts, and the reality is that most actively managed funds don’t beat their benchmark index over time.
With that in mind, here’s a list of ETFs, and a brief description of what each invests in, for beginners who are just starting to build their portfolios:
You might notice that this list is heavy on Vanguard and Schwab. There’s a good reason for this: Both are dedicated to offering Americans access to the stock market at a minimal expense, so ETFs from both tend to be among the cheapest in the business.
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 over-trading is the main reason. So, once you buy shares of some great ETFs, the best advice is to leave them alone and let them do what they’re intended to do: produce excellent investment growth over long periods of time.
An exchange-traded fund, or ETF, allows investors to buy many stocks or bonds at once. Investors buy shares of ETFs, and the money is used to invest according to a certain objective. ETFs trade just like stocks on major exchanges such as the NYSE and Nasdaq. Instead of investing a set dollar amount, you choose how many shares you want to purchase. Because they trade like stocks, ETF prices continuously fluctuate throughout the trading day, and you can buy shares of ETFs whenever the stock market is open.
Steps to Investing in ETFs
An ETF's expense ratio indicates how much of your investment in a fund will be deducted annually as fees. A fund's expense ratio equals the fund's operating expenses divided by the average assets of the fund.
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