ETF Investing for Beginners 

There are many ways for investors to build wealth nowadays. With the advent of the internet and big data, the list of potential investments has only become longer.  

With so many investments to choose from, where should investors begin? One of the best ways to start is with ETFs, or Exchange-Traded Funds.  

Since ETFs are already a collection of different investments, it can be the perfect investment tool for those new to investing. So, when it comes to ETF investing for beginners, what is the best ETF investing strategy? Are ETFs really a good investment? How do you start ETF investing? InvestmentNews provides some insight into these questions and about ETF investing so let’s delve deeper. 

What is ETF investing? 

Investing in ETFs or Exchange-Traded Funds means investing in a collection of bonds, stocks, commodities, and securities. Perhaps the simplest analogy of ETF investing is that it is the process of buying or selling a “bucket” of different stocks, bonds, and securities on the stock exchange.  

What are the differences between ETFs, stocks, and mutual funds? 

ETFs have some differences but also share a few similarities with both mutual funds or managed funds and stocks. Here’s a table to illustrate:  

Stocks are investment vehicles that can be contained in both ETFs and mutual funds.  

Here’s a short video that offers a simple explanation of what ETFs are. Should you invest in ETFs? Watch the video and keep reading this article to make an informed decision.  

Types of ETFs 

While there are many kinds of ETFs on the market, these are 6 of the most common types:

1. Real Estate ETFs 

This type of ETF contains Real Estate Investment Trusts (REITs) within the fund. As with the ETF itself, a REIT ETF can be a good investment for beginners since the fund offers relatively low risk and high liquidity.  

Here's the biggest draw: REITs by law must give out 90% of their taxable income as dividends to shareholders. This is required for REITs to maintain their status.  

Real estate ETFs can be a good source of income, especially when short-term interest rates and inflation are low.  

2. Specialty Fund ETFs 

Also known as Sector Funds, this ETF is concentrated on a specific market or industry. Specialty funds take on a focused approach to building up the investments within the fund. The fund invests only in companies that are engaged in the specific economic or industry sector.  

A specialty fund can include: 

• balanced funds 
• asset allocation funds 
• target date funds in sectors like banking, energy, or telecommunications 

3. Fixed-Income ETFs 

This type of ETF is often made up of bonds and bond ETFs and is largely involved with trading US bonds. Many financial professionals advise beginning investors to allocate some of their portfolio to fixed-income ETFs – the bonds can lessen risk while providing some added income.  

4. Commodity ETFs 

As its name implies, commodity ETFs are funds comprised of traded commodities - physical goods like: 

• gold 
• silver 
• oil 
• agricultural products 
• other natural resources 

More experienced and market-savvy investors will invest in commodity ETFs to hedge against inflation.  

Investing in commodity funds is also a way for experienced investors to gain profit when the stock exchange is in a downturn. As with any investment, this type of ETF has its share of risks and has no guarantee of profit.  

5. Equity ETFs 

Perhaps the most common of ETFs, equity funds (aka stock funds or stocks ETFs) primarily buy and sell stocks. Equity funds usually track equity sectors or indexes. This can mean that the fund imitates an entire index or uses representative sampling. Equity funds that use representative sampling can deviate slightly from an index and include some investments not typically part of the index.  

Overly aggressive representative sampling can create tracking errors in the fund. Also, an ETF with a 2% tracking error is considered actively managed as opposed to passive, which can deviate from investors’ preferred investment strategy.  

6. Currency ETFs 

To hedge against a depreciating US dollar, this type of fund deals in currencies. Currency ETFs are also a way for investors to protect their US dollar-denominated investments. In cases where the US dollar appreciates and gets stronger, investors have the option to “short” their currency ETF.  

Differences between actively managed and passively managed ETFs 

Most ETFs are passively managed, meaning that their portfolio manager bases the fund on another publicly traded index. The index determines which securities to invest in and how to do the asset allocation.  

There are also actively managed ETFs, which means that the portfolio manager does not refer to other indexes and makes all the investment decisions on their own.  

Beginning investors are advised to keep their ETFs passively managed. Only more experienced portfolio managers can manage the risk and volatility involved in taking an actively managed fund strategy.  

Benefits of ETF Investing 

There are several advantages to investing in ETFs which beginning investors may find enticing, including:  

Greater flexibility in trading 

Compared to other investments like mutual funds, ETFs can be bought and sold during the usual trading exchange hours. The price that investors will pay or receive is based on the current value at the time of the transaction, which can change throughout the trading day.  

This is preferable to the way mutual funds are traded, which is only once a day after the markets close. Mutual funds can only be traded via brokerage firms, financial advisors, or the fund provider itself – not so with ETFs, which are traded like stocks on the stock market.  

Excellent portfolio diversification 

ETFs are collections of several different types of investments, like stocks from multiple companies in the case of Equity/Stock ETFs. 

Even when they concentrate on specific bonds, industry sectors, or currencies, ETFs offer great diversification due to the variety of investments within them. This can be very helpful especially to investors who don’t have a lot of knowledge or skill in investing in these areas.  

ETFs are low-cost 

ETFs can have lower than average costs than, say, investing in the individual stocks that make up an ETF. When an investor buys an ETF, they instantly get access to all the holdings of the fund. Conversely, when they sell an ETF, they sell the entire collection of assets within the ETF. 

Making one-off transactions with ETFs is not only convenient, it also saves investors money on brokerage fees or brokers’ commissions. Some brokers or firms may even offer zero-commission trades on certain ETFs, lowering the cost of investing even more.  

Drawbacks of ETF investing 

Like any other investment, ETF investing also comes with its share of disadvantages, such as:

Potentially higher management fees

While some ETFs come with zero-commission trades, sometimes the catch can be high management fees. The cost of buying or selling an ETF is different from the cost of managing the fund.

If an investor chooses an actively managed fund, that means the portfolio manager must come up with market-beating returns. Such an investment strategy can be costly, especially if the fund does not perform as expected. Higher fees can eat into profits, so choose passively managed funds whenever possible.

ETFs may give smaller returns than individual stocks 

Although ETFs can have a diverse mix of assets and offer exposure to an index or sector that performs well, a well-chosen stock or stocks may still outdo it. Advisors or investors with the necessary expertise can build a portfolio of individual stocks that give better returns.  

Investors can have little to no control over investment choices 

As most ETFs are passively managed and follow an index, investors may find that the portfolio is not in line with their investment goals.   

The stocks, commodities, currencies, etc. within the fund may be a mix of assets that are not as liquid or as lucrative as the investor would like. To address this issue, investors may have to resort to the riskier strategy of picking out individual stocks and bonds for their portfolio.  

Like any other investment, ETFs have their share of pros and cons. However, ETF investing is often seen as a great gateway investment for beginners. Its relative simplicity, low cost and ease of entry make it appealing to investors just starting out.  

As with any other investment, investors should consult advisors to ensure that ETF investing aligns with their financial goals, risk tolerance, and time horizon.  

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