What is an ETF? And How to Invest in Them (2024)

Last Updated: By Paul Moyer

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The exchange traded funds (ETF) made their debut in the stock market back in 1993, but didn’t become widely used until another ten years later.

What is an ETF? And How to Invest in Them (1)Since then they have become a favorite of investment professionals and small time investors.

They offer many of the advantages of mutual funds, but are unique in the marketplace for how they are purchased.

What is an ETF?

Exchange traded funds allow you to invest in a large number of stocks or other investments all at one time. If this sounds like a mutual fund that is because they act very much the same.

The difference is that an ETF is traded on the stock market just like common stock. Many are created to follow an index like the S&P 500 and allow you to buy into them at a much lower rate than buying index funds.

How to Buy an ETF

As I said above, Exchange traded funds can be purchased just like common stock. This means you can buy them from any brokerage account as long as that account is on the market that you are purchasing the fund from. So if you want to purchase a stock that follows the S&P 500 you only need to have a brokerage that trades on the NY Stock Exchange (which is all of them).

Use a Robo-Advisor

What is an ETF? And How to Invest in Them (3)If you are the hands-off kind of investor but want to get involved in ETFs then a great way to go is to invest with a robo-advisor. These types of brokerage accounts do all the investing for you. All you have to do is go in and answer a set of questions so the algorithm can determine your risk tolerance.

One of the most popular robo-advisors is Betterment. Their sign up process is really simple and they have really low fees for the service. Use my Betterment review to learn more about the company and how its services work with ETFs.

Do It yourself

If you are comfortable looking at the information available you can purchase an ETF directly by yourself. As mentioned above, this can be done through pretty much any brokerage account and is as easy as purchasing a stock. Even better news is that you can avoid any commissions from some brokerages on ETF purchase and sales.

No Commission ETFs

Because ETFs are so inexpensive to trade there are brokerages that will allow you to buy ETF shares with no charge at all. The most famous of these is TD Ameritrade.

TD Ameritrade offers over 100 ETFs that you can purchase with no charge. This means when you buy or sell any ETF on their list you do not have to pay any brokerage fees. The cheapest fees on the Internet for online brokerage accounts is $4.95 a trade. So you would save that five bucks on both the purchase and sale of the ETF.

That doesn’t sound like a lot, but if you get into actively trading then you can save a bundle over time. Plus that five bucks is now invested for you and helps pump up your compound interest.

The Purchase

Since ETFs are purchased just like stocks, you just have to calculate how many shares you can afford with the amount of money you have to spend. Let’s say you are going to make a $5,000 investment that you are going to make in one ETF. If the ETF shares are trading at $35.12 and you are purchasing with a $4.95 trading fee, you can purchase 142 shares and still have $8 left over.

ETFs vs Mutual Funds

So if ETFs are so great why would anyone want to purchase a mutual fund? This is a great question and the answer is somewhat a matter of preference.

Similarities

Both of these types of accounts will follow large indexes or groups of investments. They both give you options on getting into many different types of investments all at once. So the way they react to the market is very similar, especially if you are looking at an ETF that follows an index and a mutual fund that follows the same index

Differences

The two differences between an ETF and a mutual fund are fees and initial deposit. Each time you buy or sell an ETF you are subject to fees. So if you are going to be purchasing shares in an index fund ETF a little at a time you are going to rack up fees as you go. Therefore if you are going to do a very large initial lump sum (think rolling over 401k to IRA) then an ETF is going to only cost you fees that one time, and would be the better choice. If you are looking at investing 100 dollars a month then a mutual fund is going to keep your fees much lower.

The other main difference is initial deposit. With an ETF there is no initial deposit you just purchase the shares. So whatever the share price is that day is what your minimum initial deposit will be. Mutual funds allow you to invest with dollar amounts instead of the cost of a share. To buy into the fund they usually require that you have a minimum amount around $3,000. some are more and some are less, but all of them have that initial deposit amount. So if you do not have enough to get into the fund you need to start with an ETF, until you can afford the initial deposit.

Types of ETFs

There are tons of different kinds of ETFs. Since they can follow a stock index, bonds, commodities (think gold or oil), basket of assets or even just a group of hand-picked stocks, ETFs have a lot of varieites. Instead of trying to cover every possible type of ETF here are the top 10 most popular exchange traded funds based on trading volume:

Name
Symbol
Average Volume
SPDR S&P 500 ETF
SPY
87,327,586
VanEck Vectors Gold Miners ETF
GDX
82,409,289
Financial Select Sector SPDR Fund
XLF
81,324,680
iShares MSCI Emerging Markets ETF
EEM
63,857,453
Direxion Daily Gold Miners Index Bull 3x Shares ETF
NUGT
52,339,719
Direxion Daily Junior Gold Miners Index Bull 3x Shares ETF
JNUG
42,918,902
iPath® S&P 500 VIX Short-Term Futures ETN
VXX
33,977,0592000
United States Oil Fund
USO
33,548,480
VelocityShares 3x Inverse Natural Gas ETN
DGAZ
29,270,623
PowerShares QQQ ETF
QQQ
23,681,033

As you can see, there is a wide variety even among the most popular of exchange traded funds. Just by buying into these funds you would be in large cap stocks, small cap stocks, gold, oil, and tech stocks.

It really is a great diversification tool if you are looking for a low cost option.

Bottom Line

Exchange traded funds may be one of the newer investment options available but for the last 15 years they have really grown in popularity. If you are worried about jumping in I recommend setting up an account with TD Ameritrade, choose one of their 100+ ETFs that are commission free and start with just a few shares.

This way you can get a feel for how the investments work and start working with this really awesome investment vehicle.

What is an ETF? And How to Invest in Them (2024)

FAQs

What is an ETF? And How to Invest in 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.

What is ETF and how do you invest? ›

ETFs or "exchange-traded funds" are exactly as the name implies: funds that trade on exchanges, generally tracking a specific index. When you invest in an ETF, you get a bundle of assets you can buy and sell during market hours—potentially lowering your risk and exposure, while helping to diversify your portfolio.

What is the best way to explain ETF? ›

An exchange-traded fund, or ETF, is a basket of investments like stocks or bonds. Exchange-traded funds let you invest in lots of securities all at once, and ETFs often have lower fees than other types of funds. ETFs are traded more easily too. But like any financial product, ETFs aren't a one-size-fits-all solution.

What do you actually own when you buy an ETF? ›

There is no transfer of ownership because investors buy a share of the fund, which owns the shares of the underlying companies. Unlike mutual funds, ETF share prices are determined throughout the day. A mutual fund trades only once a day after market close.

What is an ETF for dummies? ›

An exchange-traded fund (ETF) is something of a cross between an index mutual fund and a stock. It's like a mutual fund but has some key differences you'll want to be sure you understand. Here, you discover how to get some ETFs into your portfolio, how to choose smart ETFs, and how ETFs differ from mutual funds.

How do ETFs give you money? ›

Most ETF income is generated by the fund's underlying holdings. Typically, that means dividends from stocks or interest (coupons) from bonds. Dividends: These are a portion of the company's earnings paid out in cash or shares to stockholders on a per-share basis, sometimes to attract investors to buy the stock.

Are ETFs a good way to invest? ›

ETFs have several advantages for investors considering this vehicle. The 4 most prominent advantages are trading flexibility, portfolio diversification and risk management, lower costs versus like mutual funds, and potential tax benefits.

How to buy ETF for beginners? ›

How to buy an ETF
  1. Open a brokerage account. You'll need a brokerage account to buy and sell securities like ETFs. ...
  2. Find and compare ETFs with screening tools. Now that you have your brokerage account, it's time to decide what ETFs to buy. ...
  3. Place the trade. ...
  4. Sit back and relax.
Jan 31, 2024

How to choose an ETF for beginners? ›

Before purchasing an ETF there are five factors to take into account 1) performance of the ETF 2) the underlying index of the ETF 3) the ETF's structure 4) when and how to trade the ETF and 5) the total cost of the ETF.

Are ETFs best for beginners? ›

The low investment threshold for most ETFs makes it easy for a beginner to implement a basic asset allocation strategy that matches their investment time horizon and risk tolerance. For example, young investors might be 100% invested in equity ETFs when they are in their 20s.

What is the downside of owning an ETF? ›

The single biggest risk in ETFs is market risk. Like a mutual fund or a closed-end fund, ETFs are only an investment vehicle—a wrapper for their underlying investment. So if you buy an S&P 500 ETF and the S&P 500 goes down 50%, nothing about how cheap, tax efficient, or transparent an ETF is will help you.

When you buy an ETF, where does the money go? ›

ETFs COMBINE THE BEST FEATURES OF STOCKS AND MUTUAL FUNDS

A fund manager then actively manages and invests this money into a basket of different assets and securities – often stocks. You pay the manager in the hope they drive better performance than the market performance.

Which ETF has the highest return? ›

100 Highest 5 Year ETF Returns
SymbolName5-Year Return
FBGXUBS AG FI Enhanced Large Cap Growth ETN27.94%
PSIInvesco Semiconductors ETF26.84%
URAGlobal X Uranium ETF26.44%
XSDSPDR S&P Semiconductor ETF24.67%
93 more rows

What are the best ETFs to buy? ›

7 Best ETFs to Buy Now
ETFExpense RatioYear-to-date Performance
iShares Semiconductor ETF (SOXX)0.35%14.9%
Simplify Interest Rate Hedge ETF (PFIX)0.50%22.9%
WisdomTree Japan Hedged Equity Fund (DXJ)0.48%23.8%
Invesco S&P 500 Momentum ETF (SPMO)0.13%20.9%
3 more rows
May 7, 2024

Are ETFs safer than stocks? ›

Are ETFs Safer Than Stocks? ETFs are baskets of stocks or securities, but although this means that they are generally well diversified, some ETFs invest in very risky sectors or employ higher-risk strategies, such as leverage.

Do you pay taxes on ETFs if you don't sell? ›

At least once a year, funds must pass on any net gains they've realized. As a fund shareholder, you could be on the hook for taxes on gains even if you haven't sold any of your shares.

How much money do you need to invest in ETF? ›

Exchange-traded funds are similar to mutual funds in that they hold a collection of stocks and bonds in a single fund. Unlike mutual funds, they are bought and sold on stock exchanges, can be traded anytime the exchange is open, and you can start your ETF investing even if all you have to invest is $50.

What are the disadvantages of ETF? ›

Disadvantages of ETFs. Although ETFs are generally cheaper than other lower-risk investment options (such as mutual funds) they are not free. ETFs are traded on the stock exchange like an individual stock, which means that investors may have to pay a real or virtual broker in order to facilitate the trade.

What's the best ETF to buy right now? ›

  • ProShares Bitcoin Strategy ETF (BITO)
  • Global X Copper Miners ETF (COPX)
  • YieldMax NVDA Option Income Strategy ETF (NVDY)
  • iShares Semiconductor ETF (SOXX)
  • Simplify Interest Rate Hedge ETF (PFIX)
  • WisdomTree Japan Hedged Equity Fund (DXJ)
  • Invesco S&P 500 Momentum ETF (SPMO)
May 7, 2024

Is investing in ETF better than stocks? ›

Many fiduciary financial advisors favor exchange-traded funds over individual stocks for diversification and risk management. Personalized or direct indexing is a way of using individual stocks to enhance returns while simultaneously mitigating risk.

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