What is an ETF and Should You Invest in One?

One of the most common queries we get from our users is, "I want to start investing, but I don't know which company to start with?"

It's easy to tell people that investing will help shape their financial future, but most novice investors are unsure of where to start building their portfolio. Researching potential investments can take a bit of time, especially if you're still learning about the different factors that separate great investments from the rest, and even if you've already started investing, it can still be difficult to diversify your portfolio with a range of quality companies.

Thankfully, there is a way that you can instantly invest in a diversified basket of stocks straight away. Invest in an ETF!

What is an ETF?

An ETF (or Exchange Traded Fund) is a mechanism for investing in a range of stocks with a single purchase. They have become popular in recent years amongst people who want to start investing without putting in the time to research individual stocks, or holding the risk of owning individual stocks.

An ETF is a managed fund that tries to get broad exposure to a certain sector, market or style of investing. You can find ETFs that track the overall stock market, or the price of gold, or the cybersecurity sector -- there seems to be one for everything these days.

When you purchase shares in an ETF you own a fraction of all the shares that the fund owns.

Why Should I Buy an ETF?

Diversification
Firstly, an ETF is the perfect way for a first-time investor to move from zero to one. It can be intimidating to buy your very first stock, but by investing your money in an ETF, you instantly diversify your portfolio. You gain exposure to all of the underlying assets covered under the umbrella of the fund -- which means that even if some of the assets decline, the fund can still go up if other holdings are performing well.
Costs
ETFs are a lot cheaper to invest in than other types of funds. Mutual funds managers, for example, are constantly buying and selling, trying to rebalance their portfolio to hit certain benchmarks. ETFs generally are far more passive investing vehicles. The average ETF has an expense ratio of about 0.44% per year, compared to the average mutual fund fee of over 1%. This means that if you invest $1,000 in an ETF, you'll only pay about $4.40 in annual fees.
Tax Efficiency
The passive nature of ETFs also means that there are fewer capital gains taxes to be paid, as stocks included in the ETF aren't bought and sold as regularly. Capital gains taxes are taxes you pay on profits made from any asset you sell - including stocks. So if you regularly sell off stocks, you'll pay more tax on any profits you make. To avoid this, most ETFs buy and hold assets long-term, which means they pay little in terms of capital gains, leaving more money for the shareholders.

What ETFs Should I Invest In?

One of the most popular ETFs is The Vanguard S&P 500 ETF (NYSEARCA: VOO). This index tracks the S&P 500, which means that you are investing in the 500 largest companies that trade on the American exchanges. The top five holdings of this fund are currently Microsoft (NASDAQ: MSFT), Apple (NASDAQ: AAPL), Amazon (NASDAQ: AMZN), Facebook (NYSE: FB) and Alphabet (NASDAQ: GOOG). Since its inception in 2010, this fund had more than trebled in value before the recent sell-off. Regardless, it has still returned a CAGR of about 8.3% per year.

In MyWallSt, we also feature the ProShares Dividends Aristocrats ETF (BATS: NOBL), which focuses on the 50 companies within the S&P that have the longest track record of year-over-year dividend growth. This means that you'll only be invested in companies that have increased dividend payouts every year for the past 25 years at least, which gives you a lot of extra security. There's a good mix of assets included in this ETF like Target (NYSE: TGT), Johnson & Johnson (NYSE: JNJ), and Abbvie (NYSE: ABBV).

Another ETF we recommend is the Vanguard REIT ETF (NYSEARCA: VNQ), which gives users the opportunity to invest in some of the best global property while generating market-beating returns and collecting dividends.

ETFs are a great way for investors of all levels to diversify their portfolio quickly and easily. An investment in an ETF might not offer the massive short-term returns some individual stocks do, but they are a solid bedrock that will support your portfolio through periods of extreme market volatility.

Do ETFs pay dividends?

Yes. An ETF will pay you out the dividends of the dividend-paying companies held within the fund on a proportional basis. However, how they choose to distribute the funds is up to the company behind the ETF. Some will pay dividends in the form of cash distribution, while others will reinvest the dividend into additional shares of the ETF.

Are ETFs safer than stocks?

Generally speaking, all public-listed equities carry a degree of risk. However, ETFs are considerably less risky than individual stocks because of their broad exposure to a range of companies and industries.

Are ETFs good for beginners?

ETFs are a good first buy for a beginner investor because they can form a solid base for a long-term portfolio, as well as give you instant exposure to a wide range of companies and sectors.