Takeaways
- An exchange-traded fund (ETF) is a basket of stocks, bonds, or other investments.
- ETFs can be bought and sold throughout the trading day.
- ETFs are popular investments for individual and retirement portfolios.
- ETFs are low-cost investing solution and offer tax efficiencies.
- ETFs are traded on exchanges and usually track an index like the S&P 500.
What is an ETF?
An Exchange-Traded Fund, or ETF, is an investment you can buy and sell on major stock exchanges like the NASDAQ or NYSE. An ETF is a collection of stocks, bonds, or other securities bundled together and traded on exchanges. ETFs generally track a specific index. Because they are bought and sold on an exchange, ETFs can be traded quickly, unlike a mutual fund (which can only be bought and sold once a day). As a result, ETFs are a convenient way to quickly add diversity to your investment portfolio.
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Advantages of an ETF
Investing in ETFs can boost your portfolio’s performance. Here are some common advantages of ETFs that make them very popular for investing and retirement savings.
- Diversity: Unlike investing in a single stock, an ETF gives exposure to a bigger market, a sector, or even a specific industry. For example, you can invest in EFTs that track computer chip manufacturers or pharmaceutical companies.
- Flexibility & Liquidity: ETFs trade continuously throughout the day, like stocks. This means you can react quickly to changes or adjustments in the market.
- Lower Costs: In most cases, ETFs will have a lower administration cost than mutual funds because they are passively managed.
- Tax Advantages: ETFs tend to create fewer capital gains distributions than mutual funds, which makes them more tax efficient in many cases.
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How Does an ETF Work?
If you want to begin investing in ETFs, it is critical to understand exactly how they work. An ETF is a collection of assets that track specific indices, markets, sectors, or industries. Some ETFs track the S&P 500, Dow Jones, or industry-specific companies. Buying a share of an ETF is like buying a slice of that larger collection of assets and sharing in the gains or losses.
When you buy or sell into an ETF, you are buying a unit of the ETF. Each unit represents an underlying claim to stocks and bonds in the ETF. ETFs are traded on the open market and their prices are determined by the supply and demand for them on the exchange. ETFs can offer similar diversification as mutual funds, with lower costs and increased flexibility.
5 Steps to Invest in an EFT
Once you are ready to start investing in ETFs, here are the five steps to take to get started:
1. Open an Online Brokerage Account
If you are new to investing, you need to open an online brokerage account. If you already have an account, you can start here. The first step to investing in an ETF is to find a platform that works well for you and ensure it is full of cash you have designated to build your net worth.
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Look for an online stock brokerage that fits your investment goals. You need to investigate their transaction fees, the range of investment options, user experience on their website and mobile app, the level of customer service, and the investment education resources they offer. Choosing the right online brokerage platform can save you time and money. You can also look for online brokerages offering promotions, which can be from free cash, commission-free trades, or shares.
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Once you have found the right brokerage, you must open your account. Opening your account is typically a quick process that you can do entirely online. This process usually includes adding your personal information, like your address, social security number, and income level.
2. Fund Your Account
Once your brokerage account is opened and verified, you must fund it before you can execute any trades. This usually involves linking your online bank account to your brokerage account. You can also mail a check or wire money into your account to have available trading funds. Make sure you only invest capital you do not immediately need. Financial advisors advocate for an emergency fund and slush fund before you begin investing.
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3. Research the ETFs
After funding your brokerage account, you need to research what EFTs to buy. Start by digging into the historical performance of the ETFs you are considering. During this process, remember that past performance does not guarantee future returns. Also, check the fund’s expense ratio because lower fees can boost long-term investments.
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Diversification is also vital to a healthy portfolio and a critical strategy for mitigating risk. Your mix of diversification should be a balance of your investment time horizon and risk appetite. Look for ETFs that spread investments across various sectors, geographic areas, or asset classes. Diversification can help reduce the impact of volatility in any single area of your investment. Great brokerage accounts will provide research tools and have comprehensive data that includes performance, analyst ratings, and more. You can also use independent financial websites to get additional investment information.
4. Buy the ETFs
After concluding your due diligence and choosing your ETFs, it’s time to make the trade. First, log into your brokerage account and select the ticker symbol for the ETF you want to purchase. Then you need to enter the number of shares or units to purchase.
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There are several different kinds of orders you can place. Market orders are instant orders executed at the currently available market price. Limit orders, however, will let you set a specific price to execute your order, which can be helpful if you want to wait until the price drops to a preferred purchase price.
5. Monitor Portfolio
After you submit your trade, it will be executed per your trade agreement. Once the order is placed, you will receive a trade confirmation. Eventually, you will see the shares of your new ETF in your portfolio.
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After you purchase your investment, you should monitor your ETF performance. Your brokerage will have tools that you can use to track the performance of assets in your account, so make sure to utilize these tools. Adjust your investments and overall strategy based on your goals and the available data.
Smart Summary
Investing in stocks, mutual funds, target date funds, and ETFs can help boost your overall investment portfolio and increase your net worth. There are many different investment strategies to consider, as well as thousands of investment options. Consulting a finance professional can help you align your investment approach with your financial goals. But whether you are investing from your individual account or your retirement account, focusing on long-term wealth creation is a tried-and-true path to financial prosperity. ETFs are an excellent tool to help you along the way.
