Investing smartly doesn’t require you to identify which stock is going to go up, look at charts constantly to make investment decisions, or know what the news about the stock market means. That’s the beautiful thing about ETFs (Exchange-Traded Funds). ETFs allow everyday people to invest in the market without needing to devote their lives to understanding all that is involved in financial markets.
There’s a misconception that many people have about investing. People think that the majority of wealth is created by people working harder than others. In actuality, most wealth is created by people having money work for them while they sleep. Owning an asset versus working for cash is the vital shift that ETFs allow individuals to make.
Think of it this way. When you buy a single company’s stock, you’re basically betting on the performance of one horse. Sometimes that horse wins, sometimes that horse trips at the starting gate. ETFs do not make bets on the outcome of one horse in a race; ETFs buy shares in all of the horses in a race.
Go back a few steps and realize what an ETF is/does: It is a collection of investments “wrapped” into one product that can be purchased on a stock exchange. By owning an ETF, you own a very small portion of many different businesses rather than one business. An ETF trades on stock exchanges and is treated the same way as any other stock, so it is easily bought and sold and understood without complex documentation or invoices.
As with everything else in the financial world, we are going to discuss the fact that the reason for creating ETFs wasn’t necessarily due to their superior convenience. ETFs arose out of the awareness of the fact that many professional investors do not have a consistent ability to outperform the market over time, and most of them are chasing after the same tiny piece of the return pie when trying to do so through “winning”. Thus, overall performance wins.
Instead of trying to figure out how to outsmart the capital markets, you now have the chance to own the capital markets through an ETF. There is no need for any kind of crystal ball to be successful, and you don’t have to have the stress of worrying about it everyday; just participate in it.
The number of different types of ETFs available is absolutely staggering, with literally thousands of them available. You can invest in countries, industries, technologies, and niche concepts. Some ETFs mimic a total stock market, while others might invest in clean energy, real estate or fast growing technology companies. If Wall Street thinks they can sell it, there is an ETF to represent it.
Now let’s take a moment to talk about the fee structure associated with ETFs, as this is where the ETF business is most often overlooked and has the greatest competitive advantage. People often don’t appreciate how important fees will have an impact on their longterm investment performance. By less than 1% reduction in return every year over a long period of time will dramatically hurt an investment’s growth potential. As such, ETFs are typically extremely inexpensive compared to other investment vehicles. By inexpensive we mean “very very inexpensive”.
Consider paying just a few dollars a year for ownership in 100s or even 1000s of companies – the math can make this possible without being a sales pitch.
As strange and simple as that sounds (and trust me, it is). The typical “investing in an ETF” process can be done with one simple click—just open up a trading account, put in a ticker symbol, click ‘buy’, and you’re done! No meetings, no pressures, and no need to wear a suit!
If you feel more comfortable getting assistance from someone else (a Financial Advisor) rather than doing it all yourself or if you experience stress when it comes to making investment choices, working with a financial advisor may be a good option for you. The point, however, is to simply take the steps to begin investing.
The other surprise for many beginners is that you don’t need thousands of dollars to get started with an ETF. In fact, the introduction of the ETF created the elimination of minimums and fees associated with mutual funds – allowing individuals to begin investing with amounts that previously would have been considered absurd, such as $50.00.
To understand the creation of the ETF, we must first discuss the mutual funds that preceded them. Mutual funds were the original option for individuals to invest in a diversified portfolio all at once, but they were very slow, clunky, and expensive compared to an ETF. An ETF has become the upgraded version of the mutual fund due to its modern, streamlined nature.
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Both ETF and Mutual Fund provide investors access to stock market growth opportunities but due to the nature of their respective investment vehicles, they have differing levels of tracking error.
If the underlying index that an ETF tracks increases by 10% and the ETF only increases by 9%, this difference is important. ETFs that track their indices well have low tracking errors.
ETFs will only continue to become more sophisticated as more companies create ETFs similar to those that are available. You may be able to invest in the entire equity market, except for all those industries that you may not like or want to receive income from, or use an investment strategy that allows you to eliminate companies with specific income-producing characteristics, without the need of being a large institution.
The last thing to cover before the end of the article—because we will cycle back to the beginning for a second—is that what matters most about your investment is not which particular ETF you select, but instead how you distribute your investment between the various asset classifications (stock, bond, and real estate). The way you distribute your investment in these categories will have a larger effect on your long-term returns than which “individual” companies (or ETFs) you invest in.
After all, we are back to the same point as when we started this post. ETFs were designed to make investing easy and cheap and have successfully removed all of the additional complexity, guesswork, and emotions that you don’t need when investing.
For me personally, that is the largest advantage ETFs provide!
