For those of us who are just starting to invest, the perennial conundrum always appears to be: “where, and how, do I start?”
Well, for both beginners and experienced investors alike, exchange-traded funds (ETFs) provide an ideal opportunity to put your investment dollars to work.
Having first found its genesis in the mid-1970s, when Vanguard founder John Bogle launched an index mutual fund – effectively the first iteration of the modern-day ETF.
So what does an ETF do? Essentially, it tracks an index (such as a specific stock market like the S&P 500 Index) and allows investors to access a wide-ranging basket of assets at relatively low cost.
For investors who are thinking about investing in ETFs, here are some great reasons why they make sense when discussing long-term investing.
Nearly no fees
While ETFs do charge a slight fee or “expense ratio”, which means deducting a percentage of your overall capital investment each year, it is a tiny fraction of what traditional mutual funds charge.
The reason they’re able to charge so little is that ETFs effectively automate the process of investing. That means that money can be allocated without human interaction or the need for a large team of investment analysts.
The end result? Cheaper running costs which then feed into lower fees for retail investors like you and me.
Vanguard was one of the best examples of this trend. The firm, along with BlackRock Inc (NYSE: BLK), are the two largest ETF providers in the world in terms of assets under management (AUM).
While the average expense ratio of a Vanguard index fund in 1975 was 0.89%, the average expense ratio today stands at 0.09%.
That’s extraordinary value for long-term investors when you compare it to annual expense ratios that range from 1.5-2% for actively-managed mutual funds.
Instant diversification
When you buy an ETF, you are actually buying a small piece of many companies in one fell swoop. On the flip side, the big attraction to picking individual stocks is that you are buying shares of a company outright.
However, the downside of that approach is that you will be extremely concentrated in just a few companies (unless you have a significant amount of money to spread over many stocks).
For example, buying shares in an ETF that tracks the S&P 500 Index in the US gives you instant access to 500 of the biggest companies listed in the US.
That’s why starting out by investing in ETFs in one of the most popular approaches if you’re beginning your investing journey.
Set and forget
Finally, for investors who don’t have the time (or energy) to research and invest in individual stocks or find the best-performing mutual funds, an ETF provides an ideal way to invest over the long term.
If you invest periodically, through a method like dollar cost averaging (DCA), then putting money into an ETF that tracks either the S&P 500 or the tech-centric Nasdaq-100 Index means you don’t have to actively track your investments.
Obviously, there should be a regular review of your investment portfolio but it certainly won’t require as much attention as an investor who holds many individual stocks or funds.
The key reason is that, for all the talk of occasional market crashes, the stock market in the US tends to rise over time.
Focus on long-term returns
If you’re an investor who is putting money away for the long term then ETFs provide a great solution to start off with.
Giving you broad diversification at low cost, ETF investing provides everybody with an equal opportunity to benefit from rising stock markets over years.
Disclaimer: ProsperUs Head of Content Tim Phillips doesn’t own shares of any companies mentioned.
