What Is ETF Stock? | How Do ETFs Make Money For You
Running Time: 8 minutes
Are you a complete Stock Market newbie? Do ETF’s and Market Indexes sound like some form of alien language to you? In this video, I am going to make this as simple as humanly possible. I’m still figuring it all out, so if I didn’t understand it, I rewrote it so that both you and I could.
This video focuses on Exchange-Traded Funds or ETFs, and the best strategies for beginners so that you can make the most of your investments. We’ll go over the pros and cons of ETFs.
What is a Stock Exchange-Traded Fund (ETF)?
A stock ETF, or exchange-traded fund, is designed to track certain industries. For example, an ETF can include Technology, Real Estate or Blue Chip (Old Companies).
You may buy a single ETF stock, but the people behind the stock are investing in other stocks.
Let’s use an example of the stock named Vanguard S&P 500 ETF, with the letter code of VOO. If you buy one share of the VOO stock, you are actually investing in a tiny share of 500 different companies, which are based on the S&P 500 Market Index (a guide) which tracks the largest companies on the stock market.
These ETFs generally follow one type of industry. A Technology ETF may buy into Apple, Microsoft, and Tesla. A Blue Chip ETF may include McDonalds, Facebook, or Johnson & Johnson. So if you were to buy one Technology ETF, you would hold a tiny percentage of a stock in Apple. If you buy one Blue Chip ETF, you own a tiny percentage of McDonalds.
But unlike individual stocks, you are not relying on every single stock to perform every day. The strongest companies of the day help keep the weaker ones up, so the stock prices generally stay fairly consistent.
An REI ETF (a Real Estate Fund, and another video) is a great investment. This is built on large publicly traded companies that buy, sell, and rent real estate.
Another great investment is Dividend Funds. Dividends are when they pay you extra, just for owning the sock, as a way to offset the companies taxes. Once again, another video, links below.
Just like other stocks, the prices can adjust through the day. With ETFs, you can take advantage of immediate diversification that’s easy to trade and low cost. It’s a great passive investment vehicle that can yield a pretty good return without you having to actively manage it. Not only has VOO come back after the pandemic crash in March 2020, it has also exceeded where it was before.
This is why ETF’s are safe. You are not investing in only one company. The strongest of the companies keep propping up the weaker ones.
So, Why are ETFs so Popular?
They’re flexible, low cost, and tax-efficient. Over a long period of time, they even have the potential to outperform actively managed funds. Here are several different types of ETFs that are available to you.
● Bond ETFs – With a bond ETF, you can get valuable exposure to different types of available bonds out there, which includes high-yield, US Treasury, international, corporate, and municipal bonds.
● Sector and industry ETFs – If you’re only looking for exposure to a certain industry in particular, sector and industry ETFs are the way to go. This provides exposure to industries like high technology, pharmaceuticals, and oil.
● Market ETFs – These are designed to track a particular index, with the likes of the S&P 500 or the NASDAQ.
There are actually quite a few more, but I trimmed the list down to some of the more obvious ones.
What are the Pros and Cons of ETFs and How DoThey Work?
Similar to a stock, you can buy and sell an ETF when the stock exchanges are open. You can base your investment decisions on the ticker symbol and price data throughout the trading day.
Keep in mind that ETFs, by nature, are incredibly easy to trade, mainly because you can buy and sell pretty much whenever you want to at any time in the day. Because they are index-based, you can rely on a whole lot of transparency since they’re required to publish holdings every day. They’re also very tax-efficient because they generate a lower level of capital gain distributions.
What are the Best ETF Strategies for Beginners?
As a beginner investor, you can always go with Dollar-Cost Averaging or DCA. DCA means that you buy an asset at a certain fixed-dollar amount on a regular schedule. This means buying regardless of the asset’s changing cost. For Example, buying $100 worth, each and every month, regardless of the actual cost on that day. The goal is that the stock will always go up.
You can also use ETFs to get exposed to any market in the world regardless of the industry sector. It’s an extremely flexible way for you to weave in and out of markets, add alternative assets like commodities or even gold, and adjust your allocations based on changes in your overall risk tolerance and investment goals.
Another type of investing is called Swing Trading – This is what I personally use. Swing trading is a style of trading that attempts to capture short – to medium-term gains in a stock over a period of a few days to several weeks. Basically, you can calculate the true value of a stock by going back a few weeks, and draw a diagonal line across the high values and low values of the stock. Because ETFs by nature have wide bid/ask spreads and have plenty of room for diversification, they can be really effective for swing trading. Buy when the stock goes below the estimated threshold, sell whenever you’re comfortable.
When Should You Invest in ETFs, and Why You Should.
ETFs come in handy when you have a huge chunk of money lying around, say from stimulus checks or money rolled over from an old 401(k) to an IRA. With an ETF, you can invest smaller, lower risk amounts and still be able to diversify and assemble a pretty decent portfolio.
Make sure that you buy ETFs from trusted brokers or a brokerage account like WeBull, Robin Hood, or M1 Finance (links below). Consider what the index tracks, how the ETF is constructed, and how long it has been around plus its historical performance.
Remember that your investments will always have tax consequences (unfortunately). While ETFs can be relatively tax-efficient as they are due to their nature, some ETFs that have less-static indexes that trade more frequently may lead to more capital gains costs, which is why it’s crucial to look at the big picture when you’re picking out the best fund to invest in. It’s not going to be enough to check a fund’s historical performance—just because something does really well in the past doesn’t mean it’s guaranteed to do just as well in the future.
How, then, should you choose the right one that’s best for you? Pick the fund that will go perfectly in sync with your trading goals, time horizon, risk appetite, and your budget.
ETFs vs. Stocks: Which One Should You Choose?
First, you have to figure out what your investing objectives actually are. No two traders will be exactly the same—most will have specific exposure requirements about the trade, whether it’s related to a specific stock type or sectors such as construction or financial services.
Second, you have to consider your own risk appetite. Are you a high risk, high return kind of person, or do you prefer to keep it nice and safe when it comes to your hard-earned money? Are you the type to go all or nothing on your investments? I mean, does it even make sense for you to take on so much risk if your own financial status doesn’t look too good? Beginners should never over-expose themselves to unnecessary risks.
Third, figure out what your investment timescale is. The length of the investment will help you figure out whether you’re more inclined to take on stocks or more suited to ETFs instead. And finally, always make sure that you stay within your financial means, and know how much your budget is.
As a beginner, investing may seem overwhelming at first, which is why you need low-cost alternatives to stocks, at least until you get the hang of things. ETFs offer that kind of flexibility and safety, which is extremely valuable for someone who’s financially unstable.
Before you even dismiss all of this as something you don’t even want to do, remember that investing is one of the most effective ways you can get to that sweet, sweet financial freedom. Don’t be afraid of investing just because everything looks so complicated. Like any other skill, you just need to practice a bit first.
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This will be a longer version of the previously published video about ETF’s. We had so much material left over, I decided to strip all the extra information out for a simpler to follow video. However, I am releasing this version that has 6 or 7 minutes of extra information about ETF’s for anyone who wants a fully researched video covering the topic. I’ll have a link to the shorter version below.
Some Starting Definitions
A Market Index is basically a gauge on how the Stock Market is doing, as a whole, for any given day.
Mutual funds are investments that pool your money together with other investors to purchase shares in a collection of stocks, bonds, or other securities, referred to as a portfolio. Mutual Funds are typically overseen by a portfolio manager.
An Index Fund is a type of Mutual Fund with a portfolio (collection of stocks) constructed to match or track the components of a Market Index. The three most widely followed indexes in the U.S. are the S&P 500, Dow Jones Industrial Average, and Nasdaq Composite.
To be clear, a Market Index is a guide. A Mutual Fund is where multiple people invest in the same stocks together. And an Index Fund is where a group of people invest in the same Mutual Index stocks together AND those stocks are based on a Market Index that’s used as the guide.
● Foreign market ETFs – You can track non-US markets here, including the Nikkei Index in Japan or the Hang Seng Index in Hong Kong.
● Commodity ETFs – There are also commodity-specific types, where you can track the price of a particular commodity like corn, gold, or oil.
● Style ETFs – Style ETFs, on the other hand, can track a market capitalization focus or an investment style, for instance, large-cap value or small-cap growth.
● Exchange-traded notes (ETNs) – These are debt securities that are backed by the issuing bank’s creditworthiness. With this, you can gain access to ill-liquid markets without generating short-term capital gains taxes.
● Inverse ETFs – If there is a decline in the market, then inverse ETFs are designed to profit from them.
● Actively managed ETFs – These can outperform an index rather than track an index.
● Alternative Investment ETFs – Finally, Alternative investment ETFs are considered as innovative structures that provide opportunities for investors to trade volatility. These can also help expose you to certain investment strategies like covered call writing or currency carry.
Quick Definition: A Bid is to buy a stock, and Ask is to sell a stock.
With an ETF, you can easily diversify across horizontals, but they can be more difficult to unload since some ETFs aren’t traded as frequently. These tend to have wide bid/ask (buy/sell) spreads. This can lead you to selling lower than you want, as they dont jump around all day long like the Tech industry does
You also run the risk of tracking errors and technical issues that can lead to costly discrepancies. To top it all off, the settlement dates can keep you from reinvesting right away. ETF sales are not settled for two days following a transaction, so your funds won’t be available to reinvest for two days. And technically, if the fund hasn’t brought in enough assets to cover administrative costs, there’s a risk that the ETF will close, and investors might have to sell at a loss.
Let’s go through a few more strategies you can use:
● Seasonal Trends Betting – with an ETF, a beginner investor can easily capitalize on seasonal trends. For example, you can “sell in May and go away”, because historically, U.S. equities have been known to underperform over the six-month May-October period. This is relatively low compared to the November-April period year after year.
● Hedging – this kind of strategy is a good beginner trick to hedge or protect against any downside risk in a portfolio, especially if this portfolio has been acquired in an inheritance of some sort.
Before you even begin to invest, consider your costs first. Check an expense ratio to determine how much the ETF costs, and remember to factor in the brokerage commissions you need to pay to buy and sell your ETF shares. The three brokerages I just mentioned don’t have any extra selling fees.
On top of these hidden commissions, some funds will also charge an extra management fee, say, if you’re going to invest in a life-cycle fund that invests in ETFs. Target-date funds normally don’t charge these extra management fees, so if this will end up saving you money in the long run, be sure to consider it (do a side-by-side comparison if you have to).