Complete Guide To ETF Investing For Beginners

Do you want to know more about ETFs? Do you want to get a good idea on what they are and how to use them? This complete guide to ETF investing for beginners is made just for you. 

Let’s start by understanding what is this thing called ETF. If you need more clarity, feel free to check the metrics section.

What is an ETF? 

ETF is an abbreviation, and it means exchange-traded fund. But what is this you might ask? Simply put, a fund is a basket of stocks grouped together, managed by someone. They can be actively or passively managed and can be grouped based on all kinds of things. But more on that in a moment.

Being exchange traded means that they are traded on an exchange, just like any other stock. Which means that you can buy them from your investment platform. This makes owning ETFs really easy, and that is why they are getting very popular.

Many mutual funds can also be purchased through your investment platform, but it is not always as easy as an ETF.

Mutual Funds vs ETFs

There are some misconceptions around those two. They are indeed kind of similar, but they have their differences. We can start by saying that they are both funds. Which means that both of those are essentially a basket of a given asset or a mixture between a couple of different asset classes.

There are a couple of differences. A lot of ETFs are passively managed, while every mutual fund is actively managed. Passively means that it is built on a certain index and it keeps it this way, without much of a need to change positions within it.

For example you can have an ETF that only holds the all the companies in the technology sector. This is all preprogrammed and it is adjusted passively if there is a change in that sector. But in the other time the ETF stays pretty much the same. 

Mutual funds on the other hand have active manager that trade stocks and reallocates capital within it. That means there are often bigger teams behind a given mutual fund, because they do more research, more trading, more active managing. 

Here comes the biggest difference- the cost, or the fees that you pay to the fund every year. Every fund have a given fee, after all that’s how they make money. This study by Morningstar shows that the average fee for an actively managed mutual fund is 0.67%. The fee for passively managed funds is only 0.12%. 

To understand this a bit better- those are the operating fees that the fund keeps every year. So an active managed fund keeps 0.67% on average against 0.12% for the passively managed one. After all it makes sense right? In one case you have a team of managers making adjustments every day, in the other you have a fund that just follows a certain criteria. 

And not one is necessarily better than the other, in fact both of those vehicles are growing. ETFs are growing quicker, but that’s normal given the fact they are easier to use. One of the graphs is for the US only, while the other one is worldwide, but you get the idea.

Types

In the investing space there are a lot of things you can invest in- stocks, bonds, commodities(oil, gold, silver, etc.), real estate, etc. You can also have leveraged ETFs and more. That means you can have ETFs that are a basket of those certain things. Let’s get a quick look through all of those. 

Stocks ETFs

This is the most popular and widely used form of ETF. As you can probably guess those are all ETFs that hold a basket of shares of different companies. Now, they can within themselves vary greatly. I will try and give you a bit more information on the main and most popular types of stocks ETFs. 

Index Funds

Those are index funds that track a given index. I will give you an example- the biggest index in the world is the S&P500. There are the 500 biggest companies in the US. So you can have a fund that tracks exactly those 500 companies, like for example the SPY. 

A main advantage of those kinds of funds is that they have a very low expense ratios and are broadly diversified. If you own one of those it means that you own a small part of all those 500 companies. You can very rarely go wrong with such a fund, it is one of the best options for long-term investors overall.

Sector Funds

Those can be tracking a certain sector of the economy. As I said, there are all kinds of different ones. So you have an ETF for industrials, for healthcare, for telecommunications and so on. 

Those are again a solid option. They have low fees and are very well diversified across the sector. With all those ETFs you also get automatic readjustments if anything changes within the sector, or within the index, or within whatever the ETF is tracking.

Region Funds

Those are ETF that can track entire regions, or continents. You have one for emerging markets, you have such for Europe and many more. Again, very good option for essentially the same reasons. Generally low fees, good diversification and automatic readjustments. 

Leveraged Funds

As the name suggests, those are funds that are leveraged. They can be 2x,3x,4x or whatever. Which means That you can make bigger returns, but also bigger loses. Also they are operating on margin, which means that their expense ratio is higher. Also those funds are way more risky than your regular ones. It is not a recommended tool for beginner, or even intermediate investors. 

Other 

There are all kinds of other ETFs, you can find pretty much everything today. You have ones that focus on renewable energy, you have ones that focus on gaming, defense and everything you can think of. Honestly, if you are looking to invest in a particular industry, there is most probably an ETF on that. 

Bonds ETFs

Similar to stock ETFs, here you can again have different kinds of bond etfs. Again, their expense ratios can vary depending on providers, so make sure you check that. Let’s take a look at a couple of those bond ETFs. 

Corporate, Municipality, Government Bonds

Those are funds that hold different kinds of bonds. The principle is pretty similar to the stock ones- you have low fees, broad diversification and different options. I will not go into detail about that, you can look through a full list of bond ETFs here.

Commodity ETFs

There are many commodities, traded on the commodity markets. And, you guessed it right, there are ETFs covering most of those as well. You can have ones on gold, silver, oil, or ones on the entire commodity markets. If you want to have exposure to a certain commodity, you can do that through ETFs.

Just for the record, those that trade commodities are called exchange-traded products, or ETPs. After all they are trading with a physical product, so you can keep that in mind. Wanted to include the ETPs here, just so you have a bit more clarity.

Active or Passive

Most of the ETFs out there are passively managed. What that means is the fund manager does not actively buy or sell positions within that fund. They usually have a set tracker, or an index and the fund just follows along. This results in simplification and lower fees for the consumer. 

Active ETFs are more rare, but you can still find them today. Here is a list of 31 actively managed ETFs. They are not as popular, because the fees are generally higher, and active fund managers tend to underperform the market. There are of course good active fund managers, but statistically speaking they are more likely to underperform the broader market. 

This article shows us that 54% of active fund managers underperform the markets. The principle is the same for mutual funds and actively managed ETFs, so keep that in mind.

Uses

In my opinion ETFs have a place in everyone’s portfolio. For example I use an ETF in my portfolio to get emerging markets exposure. Why you may ask? Well, because it is easy, you get instant diversification and generally much safer. I don’t know much about individual stocks in emerging markets, so I feel safer leaving this in the hands of a broadly diversified ETF. 

The same case can be done for all kinds of asset classes. You might want to get more tech exposure by investing in the QQQ, you might want more real estate by investing in VNQ and so on and so forth. The idea is that ETFs provide you with a quick and easy way to do that.

And as we have already seen, there is an ETF for all of your needs. You have bonds, stocks, gold and anything you can think of. In fact many people build their entire portfolios with ETFs and there is absolutely nothing wrong with that.

In fact this is the strategy I recommend for beginner investors. ETFs are a good place to start, but there are a couple of things you need to be aware of. So I will explain how to pick ETFs yourself. 

How to Pick ETFs?

There are a couple of things you need to look for when picking an ETF. First one being what is actually inside of it. To do this we go on etf.com, we write the fund we want to buy and we have all kinds of stats about it. Let’s say we want to buy the Vanguard S&P500 ETF with a ticker symbol VOO. 

The ticker is the symbol that the given security is traded on the stock market with. A simply Google search can give you the ticker symbol for any company you want to trade.

So we decided we want to buy the VOO. We go on etf.com, we type in VOO and we are taken to this page. There we can find all the information we need. You can find the fee, you can find the historical price, you can find what’s inside, the prospect and so on. 

And just like any other stock, we want to make a good research on the given ETF, before we buy. A common mistake is that people buy all kinds of ETFs without even knowing what’s inside, or how much are they actually paying for it. Most of the ETFs are a great investment, and many people assume that all ETFs are a great investment. Well, there are still some things to look out for. 

Expense Ratio

The first one is the fee that you are paying. Let’s take VOO for example- we go through the page with the information and we see that the expense ratio is 0.03%. That is a very good expense ratio for an ETF.

In fact Vanguard’s ETFs are all pioneers in those low expense ratios and passively managed funds. Usually when I am looking for an ETF I first look if Vanguard have it. They are the most suited to long-term investors and their funds suit those needs really well.

But there are a lot of funds with quite high expense ratios. For example let’s see an ETF of robotics- iShares Robotics & AI Multi sector ETF. The expense ratio of this one is 0.47%, or more than 15 times higher than the VOO. Now, nothing wrong with any of those two, but just showing you things to check before you buy a certain ETF. 

Holdings

This one is obvious, but a lot of people don’t actually check what is in the given ETF before buying in. What I do is I check at least the top 10 holdings before buying into a given ETF, usually more.

I also check on where is the ETF invested and how broadly diversified it is. Now, for most ETFs you don’t need to personally research every single company that is within it. But it is a good habit to at least go through their prospect to get an idea of the holdings and where are they situated. 

Distribution

Distribution is when the ETF pays out earnings in the form of dividends. It acts exactly the same way as a company and you get the dividend the exact same way as you would get from a stock. 

Every ETF shows in their prospect on whether or not they pay out dividends. They also show how often they pay out and you can also check what their yield is, is it growing, is the dividend growing and so on. In other words you can check all those things the exact same way you check out an individual stock. It’s really easy to do and there is tons of information online for every ETF out there. 

Just type the ticker symbol at etf.com and you can find pretty much everything that you need. Regarding dividends you can also check out stocknews, they usually have a very detailed dividend history.

There are two types of ETFs in that regard- one is distributing, and the other is accumulating. Distributing pay out dividends, while the accumulating retain those dividends and reinvest them back into more shares.

Neither of them are better or worse, just different strategies. Accumulating are better in the sense that you don’t need to pay taxes, because you are not receiving any dividends. But if you are receiving dividends, you might not need to sell for income, but rather use the dividends. 

So both have their pros and cons, you must decide which would be the better option for you. In one case you receive dividends, in the other you get further price appreciation. 

ETF Pros 

There are many pros to the ETFs, and the main one is how simple they are to use. You can buy an ETF in the same way you can buy any stock. 

Another pro for the ETFs are their generally speaking low expense ratios. Again, some ETFs actually have very high ones, so please make sure you check before you invest. You can check this article for the 100 highest expense ratio ETFs.

Some of them reach almost as high as 10% in fees. So yes- expense ratios are genuinely low on average, but make sure you check first before picking one. 

And another pro would be of course their instant diversification. Most of those funds have hundreds, if not thousands of holdings in them. By buying just one share you have exposure to all those instantly.

Another thing that can be seen is a pro is how they are passively tracking certain indexes. That means there is very little you need to do once you buy into the given ETF. They do all the readjustments for you.

ETF Cons

There are of course some cons that you need to be aware of. First one is that not all ETFs are created equal. So some of them have high expense ratios, questionable holdings, managing and more. 

Good news is you can negate that con easy- just make sure you do a good research before putting your money somewhere.

Another con for ETFs might be that you don’t have direct control over the holdings. For example if you buy into an S&P500 index funds, you buy every company that is within that index. On one hand that is great, because you get good diversification straight away. But on the other you end up owning companies that you might not otherwise want to buy. 

This can be seen as a pro, or a con depending on the point of view. On one hand you don’t need to do much, but on the other you don’t have a saying in what companies there are within that fund. 

Are ETFs a good investment?

We’ve gone through a lot of information and hope you know understand ETFs a bit better. You might still be asking yourself- are ETFs actually a good investment? And my answer is they absolutely are. But you need to be careful and do your homework, before buying into one. 

There is an ETF for every kind of investor, so whatever you are looking for, chances are there is going to be an ETF for you.

Do ETFs pay dividends? 

We covered that, but just wanted to add this, in case you’ve missed it.The short answer is that ETFs do pay dividends. They can pay dividends monthly, quarterly, semi-annually or annually, depending on the fund. If you want to know more about dividends, you can always check my beginner’s guide on dividend stocks.

ETFs have two different distribution ways. One of them is by paying out dividends, the other way is through reinvesting, or accumulation. Both are good ways, so you need to decide what is a better option for you. In one case you will receive your dividends, in the other they will be automatically reinvested for you.

 So if you need the cashflow dividends might be the better option. If you prefer price appreciation, the accumulating would be the better option. 

Which are the best ETFs?

I am sure there are going to be a lot of people asking this, so might as well answer it. And the answer is that there is no such thing as best or worst ETF. It’s the same as if you ask someone what is the best food.

For one it might be a steak, for another might be chicken, another one might not like meat at all. It’s the same with investing- everyone is different, so there would be better fits for different people. 

If you want to find the best ETF for you, there are a couple tips. First ask yourself a couple of questions. What is your time horizon, what is your risk tolerance, what do you want to achieve? 

Once you answer this question you can start doing further research into what might be the best ETF for you. If you have less risk tolerance, you might want to have more bond ETFs. If you have a higher risk tolerance, you might want to invest in a tech-heavy ETF. If you want more diversification, you might want emerging markets one, or real estate and so on.

How To Buy an ETF

As we said- buying an ETF is quite easy. All you need is a brokerage account. I personally use Freetrade, but for everyone in the US M1 Finance is a great option as well.

All you need to do is log into your account, find the ETF you want to buy and place an order. But of course, before you do that, please make sure you have made the proper research. After all we spend all that time learning this. It would not be wise to just go out and buy the first ETF that someone recommends somewhere. Make sure you invest in the one appropriate for yourself.

Summary

Ok, we went through a lot of information regarding ETFs, so I will leave you with that. Hope you now know more on what they are and how to use them in your advantage. Of course, if you have any further questions don’t hesitate to contact me. 

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