Investing can be an intimidating endeavor. But exchange-traded funds, or ETFs, can help make it easier.
What is an ETF?
It’s a basket of investments that trades on an exchange like a stock does. That means you can buy and sell shares at any of the various price points it hits throughout the day.
What's the difference between a mutual fund and an ETF?
ETFs and mutual funds are certainly easy to confuse. Both types of funds bunch many different investments into one, giving you exposure to hundreds of stocks (or bonds or other assets) with a single trade. That helps keep costs relatively low for both because you can get broad diversification without having to buy each investment individually. Plus, both ETFs and mutual funds are run by professional fund managers, so you can leave the investment analysis and in-depth research to the experts.
But there are some key differences, like…
As mentioned above, ETFs trade on an exchange and can be bought and sold throughout the day as share prices fluctuate, just like a stock. Shares of mutual funds, on the other hand, are priced just once at the end of each trading day based on their net asset value (NAV), i.e. the weighted value of all the investments within the fund at their closing prices. You can place an order for shares at any time of day, but the purchase won’t be executed until after the closing bell.
Mutual funds often come with minimum initial investment requirements of $1,000 or more. (Once you’re in, you can usually buy more in smaller increments.) With ETFs, you can invest however much you want, even if it’s just enough to get you a single share. Through Acorns, you can even invest in fractional shares. So you can start investing through Acorns with as little as $5.
ETFs tend to charge lower expense ratios than mutual funds. (Hint: An expense ratio is the annual fee you have to pay when you invest in a fund, expressed as a percentage of your investment. So if you invest $1,000 in a fund, and its expense ratio is 1 percent, you pay $10 a year.) That's because most of them are designed to track an index, such as Standard & Poor’s 500-stock index, meaning they should need less upkeep than actively managed mutual funds. Indeed, the average expense ratio for an actively managed fund in 2019 was 0.74 percent. For an index equity ETF, it was 0.18 percent, according to the Investment Company Institute.
Note: You may be able to save some on mutual funds by buying directly from the fund company and skipping any trading fees a broker might charge.
What types of ETFs are there?
All kinds. You can pretty much find an ETF for whatever type of investment you’re looking for—be it stocks, bonds, commodities, currencies or specific sectors (like retail or technology). You can even find ETFs to serve certain investing strategies. For example, dividend ETFs focus on generating income through dividends for investors, and inverse ETFs aim to make money when their underlying investments fall. And despite ETFs being originally designed to track an index, there are now hundreds that are actively managed.
(Acorns portfolios include a range of ETFs, with exposure to thousands of stocks and bonds, to suit every type of investor. The most conservative portfolio includes bond ETFs, such as iShares 1-3 Year Treasury Bond ETF (SHY). And on the opposite of the risk spectrum, more aggressive ETF investments include the Vanguard Real Estate ETF (VNQ) and Vanguard FTSE Emerging Markets ETF (VWO) funds.)
How do I invest in an ETF?
You can buy shares of ETFs through any investment account (including your Acorns account, if you’re a customer) just as you would individual stocks. You can specify either the number of shares you want to purchase or the amount of money you’d like to invest at a given time or share price.
What else should I consider when investing in ETFs?
Risks. While the basket-of-investments approach of ETFs helps reduce risk with its built-in diversification, it doesn’t get rid of risk entirely. And just how risky an ETF is depends on its underlying assets. For example, just as stocks are typically riskier than bonds, stock ETFs are riskier than bond ETFs. And going with an ETF focused on a specific sector comes with more risk than investing in a broad market index ETF.
Also note that index ETFs (and index mutual funds, for that matter) are meant to match their benchmarks, not beat them. That means that in good times, such investments should generally do well. When times turn bad though, as they did in spring of 2020, following an index down won’t feel quite so good. But remember that every market downturn has ended in an upturn. The stock market’s grown significantly over the long term, so it pays to hang on during rough spots and stick with your strategy.
And whether you prefer index ETFs or a more niche variety, these investment vehicles can be a smart, low-cost way to grow your money. You just need to be sure you’re using them to build a well-diversified portfolio, custom fit to achieve your own long-term financial goals.
Investing involves risk, including loss of principal. Past performance does not guarantee or indicate future results. This information is being provided for informational purposes only, and is not intended to provide, and should not be relied on, for accounting, legal or tax advice. You should consult your tax or legal adviser regarding such matters.