ETF Investing: The Easiest Way to Grow a Diversified Portfolio?
In October 2021, news hit about the first bitcoin ETF (in the US), creating more hype for both cryptocurrencies and ETFs. If you’re wondering exactly what an ETF is and whether you should consider investing in one, you’re not alone. Here’s a comprehensive breakdown of everything ETFs are and whether ETF investing is the right choice for you.
Did the recent news about the first crypto ETF launched in the US leave you wondering what an ETF even is? Contrary to what some might think, bitcoin enthusiasts didn’t invent ETFs—they just gave them more publicity. And if you’re looking for a way to make your money move while exposing yourself to a variety of asset types without needing advanced knowledge, ETF investing could be the perfect way to do it.
But whether you decide to go for an ETF that targets cryptocurrencies or more conventional investments, make sure you know your stuff before you go all-in. To help you, we’ll take a deep dive into what ETFs are, how they work, and why you should consider investing in them.
Introducing ETF Investing
Let’s start with a definition. ETF is an acronym for exchange-traded funds—in other words, a fund traded on exchanges. This summary contains the two most important aspects of the asset. Since an ETF is a marketable security, you can trade it live on exchanges during market hours, just like a stock (unlike mutual funds, which are only traded once a day). Secondly, because it’s a fund, it contains a selection of investments.
Think of it as a portfolio containing dozens, hundreds, or even thousands of different assets that you can invest in as a bundle.
For example, the S&P 500 contains 505 companies—that’s the 500 you’d expect given the name plus a few companies that have multiple shares associated with them (just to complicate them). Investing in a selection of the best-performing companies in the US gives you a diversified portfolio compared to picking individual firms to track, but it’s far easier to buy an S&P 500 than to buy all 500 stocks separately.
Types of ETFs
We’ve already mentioned that ETFs can contain bitcoin or stocks, but this is just skimming the surface of the ETFs out there—they might also consist of bonds, commodities (like precious metals), or other types of assets.
Here are a few more specific types of ETFs it’s essential to know about:
- Sector ETFs. Contain stocks of companies in a particular industry (e.g., technology firms).
- Inverse ETFs. Short stocks so that investors bet on the price of the assets declining rather than increasing in value.
- Leveraged ETFs. Use derivatives to maximize returns by going into debt (but also carry more risk).
- ESG ETFs. Represent more choices for conscious investors that only contain stocks with good environmental, social, and governmental impact.
ETF Investing Strategies
Although investing in ETFs can be as simple as buying a fund and waiting, it’s best to follow a more thought-out strategy. Most investment strategies are best left to the pro traders, but here are a few that even beginners can consider.
The simplest option is dollar-cost averaging, which involves investing your money gradually over time instead of investing a lump sum upfront. Since ETF prices fluctuate over time, this ensures that you’ll get a fair price on average, boosting your chances of a moderate return.
Imagine how sick you’d feel if you invested your entire nest egg only for the market to crash, causing financial distress a few weeks later.
For those prepared to take on a little more risk, we have swing trading—instead of trying to avoid fluctuations, swing traders strategize by trying to buy at lows and sell at highs so they can profit. This usually involves holding something for just a few days or weeks rather than holding something over the long term (but it’s also different to day trading, which involves holding for just a few hours).
While this ETF investing strategy has the promise of great returns, it also carries a lot more risk, so it’s best reserved for those with at least some experience.
Another more advanced strategy you could try is seasonal investing. Since demand for certain industries is high in some seasons and low in others, their value will fluctuate throughout the year in a somewhat predictable way.
For example, demand for real estate is much greater in summer as most of us would prefer to move house in the sun than the snow; this affects stock prices along the way. However, this is somewhat risky as you never know when an unexpected event could affect the usual supply and demand trends.
How to Start Investing in ETFs
You might be wondering exactly how to get involved in ETFs, but fortunately, this might be the easiest thing in this article to get your head around.
At its core, ETF investing is pretty simple. All you have to do is figure out which ETF you want to buy, the platform you want to buy it on, and hold it for as long as you want. If you’re feeling overwhelmed, here are the key steps for beginners:
- Choose an investment app that supports ETFs, such as Robinhood or eToro, or a traditional broker like Fidelity.
- Browse the index funds available and choose one to invest in. If you’re new to this, opt for something diversified and straightforward like the S&P 500 or FTSE 100 (the UK equivalent).
- Buy as many shares as you want in the fund you’re interested in directly from the app or broker.
- Hold it and check the performance periodically. Consider investing more gradually over time.
These are the basic steps to follow, although you might also want to consider questions like researching each fund and qualifying the risks, figuring out the timeframe you want to invest over, and checking how the costs of different platforms compare.
But first, you should run an assessment of whether investing in ETFs is the right choice for you.
Should You Invest in ETFs?
If you’re considering investing in ETFs , one of the first things you’ll want to know is whether they make a good investment. And for that, a good place to start is looking at what they’ve achieved in the past. Yes, it’s not a completely reliable indicator of future performance, but it gives us something to go on.
However, it’s impossible to make a generalized prediction of how well an ETF will perform as there’s so much variation between types of ETFs. For instance, the Vanguard S&P 500 ETF enjoyed a juicy return of 26.46% between December 2020 and December 2021—but the Vanguard Total Bond Market Index Fund ETF decreased by -2.47% over the same period.
Having said that, you can take solace in knowing that ETFs are a diversified and low-risk investment as long as you choose something conservative and established like the S&P 500.
They’re also more cost-effective than similar options like ESG mutual funds since they’re passively managed for the most part (although this isn’t always true). You can also sell them at any point with no delay, meaning they’re a good choice for day traders and swing traders rather than just long-term investors.
The overall conclusion is that ETF investing can be great, but you need to do your research first to know you’re heading in the right direction.
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