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How to Invest in ETFs: A Step-by-Step Guide

Exchange-Traded Funds (ETFs) are one of the best ways to start investing as they’re cheap and carry lower risk than picking individual stocks.

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If you’re looking to invest in the financial markets passively, ETFs could be an attractive option. 

By placing a single trade, you will be investing in a fully-diversified portfolio that can consist of hundreds or even thousands of assets. These might include stocks, bonds, or a mixture of the two. Some ETFs track commodities like gold and silver

In this guide, we show you how to invest in ETFs from the comfort of your home. We also explain how ETFs work and what risks to consider before investing.

How Do ETFs Work?

In simple terms, exchange-traded funds (ETFs) allow you to invest in a diversified portfolio through a single trade. ETFs are managed by institutions such as iShares and Vanguard — who in turn, pool funds together from thousands of individual investors.

Then, the ETF provider will buy and sell assets on your behalf. Unlike mutual funds, ETFs are tasked with tracking a market, rather than outperforming it. 

For example, an ETF might track the Dow Jones, meaning it will buy shares in all 30 companies that represent the index. This will be at a proportion weight, ensuring the ETF tracks the index as closely as possible.   

Once you have invested in an ETF, you can grow your capital in two ways: through dividends or an increase in the Net Asset Value (NAV).

Note: Some ETFs are actively managed, which we discuss in more detail later in this guide. 

Investing in ETFs in Four Simple Steps

So now that we have explained what ETFs and how you can make money with them, we are now going to show you how to invest today. 

Step One: Open a Brokerage Account 

The first step is, of course, choosing a suitable brokerage firm. After all, your chosen broker will sit between you and your ETF investments. There are hundreds of online brokers that allow you to invest in ETFs, many of which offer commission-free trades. 

DIY Investing

If you are comfortable choosing ETF investments on a DIY basis, then consider the likes of Webull, TradeStation, or Public.com. These online brokers offer brokerage accounts to retail investors — meaning the end-to-end ETF investment process is typically very straightforward.  

Many online brokers also allow you to partake in fractional ownership, meaning that you can purchase a small ‘fraction’ of one ETF share. For example, Fidelity permits a minimum ETF investment of just $1. 

Robo-Advisor

If you like the sound of ETFs but you don’t quite have the financial know-how to pick your investments, it might be worth considering a robo-advisor

This makes the ETF investment process even more passive, as the platform will determine which funds to allocate you based on your financial goals and attitude to risk. 

For example, the likes of Betterment, SoFi Automated Investing, and Acorns will ask you a series of questions to ascertain what type of investor you are. Then, the robo-advisor will assign you a ready-made portfolio of ETFs.  

Although the robo-advisor option is potentially more suited to newbies — the fees will be higher. This is because, in addition to the ETF provider’s annual expense ratio, the robo-advisor platform will also charge you an ongoing fee.

Note: Compared to mutual funds that only trade once a day, ETF prices fluctuate throughout the day as they are bought and sold.

Step Two: Choose an ETF to Invest In 

Once you have selected a suitable brokerage account, you then need to think about which ETFs you are interested in. Of course, if opting for the robo-advisor route, then your portfolio will be assigned for you. 

Passive or Active

In the vast majority of cases, ETFs are passively managed. This means that they simply look to track a particular asset or market like-for-like. 

For example, if the ETF is looking to track gold, it will ensure that virtually all investor funds are backed by physical gold. Or, if the ETF is looking to track the FTSE 100, it will buy shares in all 100 constituents at the correct weight. 

On the other hand, if the ETF is actively managed, the provider will have more flexibility in which assets it buys and sells and when. For example, the ARK Innovation ETF will invest in companies that the fund manager deems offer distributive products and services.  

There are pros and cons to both options here, so you need to think about your financial goals. 

For example, if you simply want to create a long-term investment plan that focuses on the US stock markets, an ETF that tracks the S&P 500 is arguably the best option on the table. 

However, if you’re looking to invest in a diversified basket of yield dividend stocks, an actively managed ETF might be better. This is because the fund manager can personally select the dividend stocks that are added to the ETF portfolio rather than religiously following an index.   

Commissions

When you invest in an ETF, you might need to pay a commission. This is determined by the online broker you signed up with and not the ETF provider itself. Fortunately, as noted earlier, many brokerage accounts now allow you to invest in US-listed ETFs for free. 

This means that you can enter and exit the market at any time without being charged. A commission will likely be required if you want to access non-US-listed ETFs. 

Expense Ratio

On top of a potential brokerage commission, you also need to consider the expense ratio charged by the ETF provider. This is something that cannot be avoided, even if you are using a fee-free trading platform. 

The good news is that in many cases, ETF expense ratios amount to just a small fraction of a percent. 

For example, there are ETF providers — such as Vanguard, iShares, and SPDR — that track the S&P 500 at an expense ratio of just 0.03%. This means that a $5,000 investment would cost you just $1.49 per year!

Such favorable expense ratios won’t always be the case though, especially if you are investing in a non-traditional asset. 

For example, ETFs that track commodities, small-cap stocks, or emerging markets will likely cost much more. This, however, is often still below 1% annually. 

Source: Giphy

Dividends and DRIPs

If you’re investing in ETFs that are holding dividend-paying stocks or bonds, you will be entitled to your share. As we explain in our FAQ section, this will be proportionate to the amount you have invested in the ETF and the payment is usually distributed every three months. 

Additionally, it’s worth checking whether or not your chosen broker offers an automatic dividend reinvestment plan (DRIP). This will allow you to automatically reinvest your quarterly dividends as soon as they are received. 

In doing so, you will benefit from the long-term impact of compound growth. In simple terms, this means that with each subsequent dividend investment, you are increasing the size of your ETF position without needing to add more funds.  

Performance

You should explore what the past performance of the ETF in question looks like. 

If, for example, you are invested in a passively managed index fund, you should compare its performance to that of the ETF. There will always be a slight difference between the two, albeit, too much of an unfavorable disparity means you are making less than you could be. 

If you are investing in an actively managed ETF, then you won’t have a specific benchmark to compare again. But, you should assess how the ETF has performed over the past five to 10 years nonetheless. 

Diversification

You should also assess how well-diversified your chosen ETF is. For example, some ETFs give you access to thousands of stocks and/or bonds from a variety of markets, exchanges, and economies. 

This ensures that you are not overexposed to a single group of assets. At the other end of the scale, an ETF that tracks gold, silver, or oil will see you overexposed to the asset question — which means your risk of loss is higher. 

Step Three: Place an Order 

Once you have decided which ETF(s) you wish to invest in, it’s time to place an order with your chosen broker. 

This part of the process is fairly easy – especially when using a trading platform that is aimed at retail investors. In fact, in many cases, it’s just a case of entering your stake and confirming your investment. 

With that said, some online brokers require you to fill out a more detailed order form, which will look at the following:

  • Ticker Symbol: ETFs are listed on stock exchanges, so will always have a ticker symbol. This will make it easier for you to find your chosen ETF.  
  • Bid/Ask Price: The bid price represents the price that you can currently buy the ETF at. The asking price refers to the price that sellers are willing to accept. The gap in pricing is known as the spread. 
  • Number of Shares: If using a broker that supports fractional ownership, you can usually enter the dollar amount that you wish to invest. If not, you will need to enter the specific number of ETF shares that you wish to purchase. 
  • Order Type: By placing a market order, you will be buying the ETF at the next available price, which means the order is executed immediately. A limit order, however, allows you to specify the price that your ETF trade should be entered at. You can also deploy a stop-loss order, which will see your ETF position closed if it goes down by a specific amount (e.g., 10%). 

Once you have set up your orders, check over the information before confirming the trade.  

Step Four: Monitor & Manage Your ETF 

Assuming your ETF order has been filled at your chosen brokerage, you now need to think about how you intend on keeping tabs on your investment. 

After all, most ETFs are passively managed, meaning that your investment is tasked only with tracking the respective market. 

For example, if you are invested in an ETF tracking the Dow Jones and the wider stock markets are on a downward trajectory, your investment will follow suit.

To ensure your ETF investment remains aligned with your financial goals, consider the following:

Reinvest Dividends 

The worst thing you can do when you receive a quarterly dividend is to allow the funds to remain idle. Instead, you can grow your money much faster by investing the dividends back into the ETF. Even better, if your chosen broker offers DRIPs, this will be done for you automatically.  

Source: Giphy

Dollar-Cost Averaging 

On top of a regular dividend reinvestment plan, it’s also worth considering a dollar-cost averaging strategy. This can be as simple as investing $100 into your ETFs each week or month. 

Not only will this ensure your investment portfolio continues to grow with time but your exposure to short-term market trends will be reduced. 

This is because on each weekly/monthly investment, you will obtain a different cost price. 

Consider Rebalancing 

One of the main attractions of investing via a robo-advisor is that your ETF portfolio will benefit from regular rebalancing. This means that the ETF provider might decide to reduce your exposure to a single ETF or remove it completely. 

If you are investing on a DIY basis, then this is something that you will need to consider yourself. You can do this by assessing whether you have too much money invested in a particular market, such as growth stocks. 

You should also consider wider market conditions and how this relates to your ETF portfolio. 

Benefits of ETFs

There are many benefits of investing in ETFs, such as:

  • Passive Income: There is no need for you to personally pick and choose assets when investing in an ETF, as this role is reserved for the provider. 
  • Low Cost:  Most ETFs charged an expense ratio at just a fraction of 1%. For example, investing in the S&P 500 through Vanguard, iShares, or SPDR would cost you just 0.03% per year.  
  • Liquid: ETFs trade just like stocks, meaning you can enter or exit the market at any time during standard hours. 
  • Instant Diversification: Some ETFs contain hundreds or even thousands of assets, allowing you to diversify through a single trade.
  • Access Difficult Markets: In many cases, ETFs give you access to markets that, as a retail investor, you might find difficult to reach. This includes the likes of stocks from the emerging economies and foreign-issued government bonds. 

Downsides of ETFs

Like with all investments, you also need to consider the downsides of ETFs:

  • Restrictive: When you invest in an ETF, you have no say in which assets the provider buys and sells. This means that you might be missing out on other investment opportunities.  
  • Market Cycles:  If you are invested in a passive ETF, you are bound by the same market downfall as the respective market. For example, if you are invested in a stock market index that is on the decline, the value of your investment will all fall.   
  • NAV vs Benchmark: There will always be a slight gap between the ETF NAV with that of the benchmark it is tracking. But, if the NAV is too far away from the benchmark, this in itself is an opportunity cost. 
Pro Tip: Before you decide to put all your eggs in one big ETF basket, think about when you’re planning on using that money, as there may be better short term investment strategies for you, like a Bonds and CDs.

FAQ: How to Invest in ETFs

We’ve found some of the most frequently asked questions around the web about how to invest in ETFs. Here are our answers.

How Do You Make Money with an ETF?

There are two main ways to make money with an ETF: you can make money via dividends or through increases in the Net Asset Value (NAV).

ETF Dividends

Most ETFs distribute dividends every quarter. If they do, this is because the assets held by the ETF generate income. 

This might include stocks that pay dividends or bonds that yield coupon payments. Either way, as an investor in the ETF, you are entitled to your share. 

For example, if at the end of the first quarter, the ETF yields 2% in dividends and your investment amounts to $5,000, you’ll receive a payment of $100. 

Not all ETFs pay dividends though, especially those tracking commodities and growth stocks. 

ETF Net Asset Value (NAV)

The NAV refers to the total value of the assets held by the ETF at the current market rate. 

In simple terms: 

  • If the ETF held one million Apple shares at a current stock price of  $100 each, its NAV would be $100 million.  
  • If a few months later, Apple shares go up to $120 each, the NAV would stand at $120 million.
  • This means that the NAV increased by 20%.

Had you originally invested $5,000 into this ETF, your capital would now be worth $6,000. This is because the NAV has since grown by 20%. Of course, this is an overly simplified example, as an ETF wouldn’t hold just one stock. 

What Is the Difference Between an ETF and a Mutual Fund?

There are many similarities between an ETF and a mutual fund, as both will pool investors together, give you access to a diversified portfolio of assets, and buy and sell assets on your behalf. Perhaps the main difference is that mutual funds are actively managed, while most ETFs are tasked with passively tracking a specific market. 

What Is the Difference Between a Stock and an ETF? 

Both stocks and ETFs trade on public exchanges, meaning the underlying price of the asset will fluctuate throughout the day. However, while a stock represents ownership in a company, an ETF typically contains a full basket of different assets. 

Who Should Invest in ETFs?

ETFs are suitable for investors of all shapes and sizes. Whether you are looking to invest in the financial markets passively, wish to access a difficult-to-reach group of assets, or want to create a highly diversified basket of instruments, ETFs are likely to be of interest.  

Do ETFs Pay Dividends?

Yes, many ETFs do pay dividends. This will be the case if the ETF is holding bonds or dividend-paying stocks. Your dividends will usually be paid by the ETF provider every three months. 

Are ETFs a Good Investment?

Many ETFs do represent good investments. But, don’t forget that most ETFs are tasked with tracking a specific market. This means that if the underlying market is performing badly, so will the ETF.  

Final Thoughts

If you are looking to build a long-term investment plan in a diversified manner, ETFs are well worth considering. Through a single trade, you could be purchasing a basket with thousands of stocks and/or bonds. 

This ensures that you can invest in the financial markets in a risk-averse manner, as you won’t be overexposed to a single group of assets. Perhaps the most challenging part is choosing an ETF that meets your financial goals and attitude to risk. 

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