"How many millionaires do you know who have become wealthy by investing in savings accounts? I rest my case." Robert G. Allen.
Allen's words resonate more than ever today. While savings accounts offer security, their returns often fail to outpace inflation, making them a poor choice for wealth building. Stocks, though riskier, provide opportunities for compounding growth—essential for long-term goals like retirement or major life expenses.
For beginners looking to enter the investment market, Exchange-Traded Funds (ETFs) offer an ideal starting point.
Combining the diversification of mutual funds with the simplicity of stock trading, ETFs open the door to the $13 trillion global investment market.
This article unpacks how ETFs work and why they're a smart move for new investors.
Key Takeaways
- As of the end of May 2024, there were over 12,000 ETFs listed globally, and total ETF assets under management (AUM) were around $13 trillion, up from $10.1 trillion in the previous year. (J.P. Morgan)
- A 2023 Smart Asset report revealed that index equity ETFs had an average expense ratio of 0.15% and bond ETFs of 0.11%, compared to 0.42% for equity mutual funds and 0.37% for bond mutual funds.
- Under SEC Rule 6c-11, ETFs are required to disclose their portfolio holdings each business day before trading begins.
Understanding the Basics of ETFs
Exchange-traded funds (ETFs) are investment vehicles that combine the diversification of mutual funds with the trading flexibility of individual stocks.
A mutual fund is an investment fund that pools money from multiple investors to purchase securities, categorized by principal investments such as money markets, bonds, stocks, or hybrids.
Currently, Vanguard and Fidelity are among the big fishes in the U.S. mutual fund market in 2024.
While mutual funds share several similarities with ETFs, it maintains some distinct differences like higher expense ratios, minimum investment amount, fund-manager-led trading and once-daily pricing instead of intraday.
The history of ETFs is a fascinating journey of financial transformation and breakthrough.
In 1990, the Toronto Stock Exchange introduced the Toronto 35 Index Participation Units (TIPs 35), effectively creating the first ETF-like instrument. (Canada Newswire)
However, the modern ETF era truly began on January 22nd, 1993, when State Street Global Investors launched the SPDR S&P 500 ETF (SPY), which remains the largest fund globally, with over $500 billion in assets.
The market experienced exponential growth: from a single fund in 1993 to 102 funds by 2002 and nearly 1,000 by 2009. (Investopedia)
As of 2024, the global ETF market has exploded to over 12,000 funds managed by approximately 600 fund management companies. (Investopedia)
Understanding how ETFs work reveals their unique appeal.
Take the Vanguard Consumer Staples ETF (VDC) as an example. This fund tracks the MSCI US Investable Market Consumer Staples 25/50 Index and holds shares in 104 companies.
With a minimum investment of just $1.00, investors can instantly own a piece of industry giants like Proctor & Gamble, Costco, Coca-Cola, Walmart, and PepsiCo. (Investopedia)
This structure provides instant diversification and accessibility.
The ETF market offers diverse investment options across multiple categories:
- Stock ETFs: Track equity indices like the S&P 500 (SPY) or technology sectors.
- Bond ETFs: Invest in government, municipal, or corporate bonds.
- Sector or Thematic ETFs: Focus on specific industries like technology, healthcare, or emerging trends.
- Index ETFs: Mirror broad market indices, providing comprehensive market exposure.
- Commodity ETFs: Track prices of raw materials like gold, oil, or agricultural products.
From the tech-heavy Nasdaq-100 ETF (QQQ) to the total market Vanguard Total Stock Market ETF (VTI), these instruments offer investors unmatched flexibility, lower costs, and simplified access to complex investment strategies.
Key Benefits of ETFs for Beginners
ETFs can be your ideal starting point for a beginner exploring the financial market. Whether your goal is long-term growth, steady income, or simply learning the ropes, ETFs offer a flexible, low-risk way to invest that suits your financial goals, risk tolerance, and monthly budget.
Low-cost exposure to multiple assets
ETFs allow investors to diversify their portfolios with minimal capital by bundling various securities—such as stocks, bonds, or commodities—into a single investment.
For example, the SPDR S&P 500 ETF (SPY) offers exposure to all 500 companies in the S&P 500 Index, reducing the risk associated with investing in individual stocks. (State Street Global Advisors)
This diversification helps mitigate risk, as poor performance from one asset can be offset by better performance from others.
Research shows that diversified portfolios can reduce volatility by up to 40%, offering investors not just peace of mind but making ETFs an excellent choice for beginners seeking stable long-term growth without incurring high costs.
Low fees compared to mutual funds
Cost efficiency is where ETFs truly shine for new investors.
According to a 2023 Smart Asset report, index equity ETFs had an average expense ratio of 0.15%, index bond ETFs averaged 0.11%, while equity and bond mutual funds averaged 0.42% and 0.37%, respectively.
The fees might seem small, but over time, the difference is substantial.
Vanguard's S&P 500 ETF (VOO), for example, charges only 0.03% in annual expenses, meaning an investor pays just $3 per year for every $10,000 invested.
Over time, these lower fees can translate to significant savings, especially for long-term investors, as high management fees erode portfolio gains.
Easy to buy/sell on stock exchanges
Unlike mutual funds that settle at the end of the trading day, ETFs can be bought and sold throughout market hours at real-time prices.
This liquidity allows beginners to enter or exit positions quickly, responding to market movements or personal needs.
In 2024, the daily trading volume of ETFs exceeded $200 billion globally, demonstrating their ease of access and adaptability for active or passive investment strategies.
Additionally, the presence of market makers ensures that there is always a buyer or seller available, enhancing the overall liquidity of ETFs. (Investopedia)
Holdings are disclosed daily
ETFs provide daily updates on their holdings, giving investors full visibility into what they own.
Under SEC Rule 6c-11, ETFs are required to disclose their portfolio holdings each business day before trading begins.
For example, an investor in the iShares MSCI Emerging Markets ETF (EEM) can review its composition daily, including exposure to companies like Taiwan Semiconductor or Tencent.
This transparency allows investors to see exactly what assets they own and understand their exposure anytime.
Daily disclosures help facilitate accurate pricing and enable market participants to identify arbitrage opportunities, ultimately contributing to fairer market conditions for all investors.
Beginners benefit from this clarity, as it aids in better decision-making and aligning investments with financial goals.
Invest in various markets and themes with ease
From technology and clean energy to artificial intelligence and global markets, ETFs provide targeted exposure without requiring extensive research or high minimum investments.
The ARK Innovation ETF (ARKK), focusing on disruptive technologies, and the Global X Robotics & Artificial Intelligence ETF (BOTZ) demonstrate how investors can strategically invest in cutting-edge sectors.
Report shows that thematic ETFs grew by 35% in 2023, indicating increasing investor interest.
This flexibility enables beginners to build diversified portfolios that align with their interests, values, and investment goals.
How to Start Investing in ETFs
To properly start investing in ETFs, you’ll need to
Understand Your Goals
Before investing, define your objectives.
Are you saving for a short-term goal like a vacation or a long-term target like retirement? Short-term investing typically involves higher risk and volatility, aiming for quick profits, while long-term investing focuses on building wealth over time through compounding returns.
Understanding your objectives will guide your investment strategy and help you select the suitable ETFs. Diversified ETFs yield an average annual return of 10% over decades, ideal for compounding wealth.
Research ETFs
Choose ETFs that align with your goals using platforms like Morningstar or ETF.com. An alternative to standard brokers is a robo-advisor like Betterment and Wealthfront.
Evaluate factors like historical performance, expense ratios, and holdings. For example, an ETF with a low expense ratio can save money over time, enhancing overall returns.
Additionally, analyzing past performance can provide insights into how well the ETF has responded to market conditions. This thorough research will empower you to make informed investment decisions.
Choose a Brokerage
Select a beginner-friendly platform to trade ETFs. Beginner-friendly platforms like Robinhood and Charles Schwab Fidelity offer user-friendly interfaces and educational resources that simplify investing.
Many of these brokerages also provide commission-free trading for ETFs, making it easier to start investing without incurring high costs.
Additionally, look for platforms that offer robust research tools and customer support to help you navigate your investment journey effectively.
Start Small
Begin with small investments using Dollar-Cost Averaging (DCA), which involves investing fixed amounts regularly.
Many experts suggest a percentage of your income, such as 10% to 15%. It can even be less. (Investopedia)
This strategy reduces the impact of market fluctuations.
For instance, if you invest $100 monthly in an ETF, you'll buy more shares when prices are low and fewer when they are high.
According to Charles Schwab, DCA helps mitigate the risks associated with market timing and can lead to lower average costs per share over time, fostering consistent growth in your portfolio.
Monitor and Adjust
Successful investing is an ongoing process of monitoring and rebalancing.
Financial experts recommend reviewing your portfolio quarterly or semi-annually. (Faster Capital)
Modern robo-advisors and brokerage platforms offer automated rebalancing tools, simplifying this process.
Key metrics to track include asset allocation, expense ratios, and performance - relative to benchmark indices.
Market shifts or life changes may require adjustments. For example, a portfolio initially heavy in equity ETFs might gradually increase bond ETFs as you near retirement, prioritizing stability over growth.
Common Mistakes New ETF Investors Should Avoid
The different mistakes that should be avoided by new ETF investors include;
Chasing High-Performing ETFs Without Research
Investors often chase last year's top-performing ETFs, a strategy that has proven ineffective. However, historical data shows that top-performing funds often regress to the mean.
Past performance doesn't guarantee future results. Comprehensive research involving fund composition, sector trends, and long-term performance metrics is key for sustainable investment strategies.
Without analyzing underlying assets and strategy, such decisions risk capital losses.
Ignoring Expense Ratios and Hidden Fees
Expense ratios significantly impact long-term returns. A 1% annual fee can reduce portfolio value by approximately 20% over 20 years.
For instance, an ETF charging 0.75% versus 0.10% could mean thousands of dollars in lost potential returns.
Hidden fees, such as transaction costs and premium spreads, also reduce profits.
Always compare expenses, as low-cost ETFs like Vanguard's VOO (0.03%) consistently outpace high-cost alternatives.
Savvy investors prioritize low-cost, efficient ETFs that minimize fee erosion.
Over-diversifying or Holding Redundant ETFs
Excessive diversification can dilute returns and increase complexity. A study by Vanguard revealed that holding more than 5-10 ETFs often provides diminishing benefits.
Many investors unknowingly hold overlapping ETFs with similar holdings, increasing unnecessary transaction costs and management complexity without adding meaningful diversification.
For instance, owning SPY and VTI duplicates exposure to U.S. large-cap equities. Simplify portfolios by ensuring each ETF contributes unique exposure, minimizing unnecessary complexity.
Timing the Market Instead of Investing Consistently
Market timing is a losing strategy.
According to a report by Hartford Funds, missing just the 10 best market days can reduce portfolio returns by up to 50%.
Dollar-cost averaging—consistently investing regardless of market conditions—historically outperforms attempts to predict market movements, providing more stable and predictable investment growth.
Why ETFs Are Perfect for New Investors
Unlike individual stocks which require extensive research, ETFs offer instant diversification by tracking entire indices, sectors, or themes.
They are more cost-effective and transparent than mutual funds, with expense ratios often below 0.10% for broad-market options.
Additionally, ETFs trade like stocks, allowing for intraday buying and selling, which is unavailable with mutual funds.
This beginner-friendly structure has fueled their popularity among retail investors, who now account for over 52% of ETF inflows globally. (The World Economic Forum)
As of 2024, the global ETF market has surpassed $10 trillion, reflecting a sharp rise in adoption driven by low costs, ease of access, and their role in building diversified portfolios.
Conclusion
ETFs are a smart, simple, and efficient investment choice for new investors, offering diversification, low costs, and ease of use.
Their beginner-friendly nature makes them an excellent starting point for building a solid financial foundation.
With a wide range of options catering to various goals, ETFs empower investors to grow wealth confidently.
The key is continuous learning—start small, research diligently, and remain committed to understanding market dynamics.
Your investment journey begins with that first step: explore, invest, and grow.
