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What are ETFs and should you invest in them?

ETFs trade like stocks but offer much more diversification. Here's what you should know.

Aleksandr Sumarokov / EyeEm | EyeEm | Getty Images
  1. There are so many ways to invest your money to build your wealth. From stocks to bonds to index funds, there's a wide range of investment vehicles for every kind of investors depending on their goals.

A common choice for beginner investors who want exposure to the overall stock market is to put money into an Exchange-Traded Fund. You've likely come across its acronym before: ETF.

What are ETFs?

Think of ETFs as buckets that hold a collection of securities, like stocks and bonds. Because ETFs are made up of these multiple assets, they provide investors instant diversification. When an investor purchases a share of an ETF, their money is spread across different investments. This differs from stocks where you buy shares of just a single company.

ETFs typically mimic a market index like the S&P 500. Since ETF performance is usually based on an index — meaning they follow the ups and downs of said index — most are passively managed investments and thus likely have lower fees than mutual funds. Mutual funds, on the other hand, want to beat the market's performance and are thus managed by a fund manager, who's actively choosing the investments.

Similar to stocks, ETFs can be bought and sold on an exchange throughout the day, and investors can even earn dividends depending on the type of index the fund tracks.

Should you invest in ETFs?

Since ETFs offer built-in diversification and don't require large amounts of capital in order to invest in a range of stocks, they are a good way to get started. You can trade them like stocks while also enjoying a diversified portfolio.

How to get started investing in ETFs

First, you'll need to set up an online account through a broker or trading platform. After funding the account, you can purchase ETFs using their ticker symbol and indicating how many shares you want.

Deciding on how many shares to buy largely depends on the current pricing of a share and your own financial situation. ETFs are good for beginners because they offer entry-level access: You can buy as little as a single share, and with some brokers, like Robinhood, you can even buy fractional shares.

Fees vary by broker, but it's best to look for options with very low or no transaction costs. These days, many of the traditional brokerages offer commission-free trading on ETFs. Some of the best $0 commission trading platforms include the below:

Though ETFs tracking the S&P 500 are some of the most popular, be aware that very few ETFs track the S&P 500 as a whole, rather just components of the index.

The Vanguard S&P 500 ETF (VOO) tracks the entire index, and it has low management fees. Its current expense ratio is 0.03%, which means you pay just 30 cents per year for every $1,000 invested. For every $10,000 invested, that would equate to $3 per year.

Bottom line

You don't have to be so hands-on in order to invest with ETFs, and investing in them is an easy way to get started in the market.

If you don't feel confident choosing ETFs, consider opening an account with a robo-advisor that automatically invests on your behalf. Many robo-advisors, like Betterment, recommend low-cost ETF portfolios so you can take advantage of this investing vehicle without having to do your research on all the different options available.

Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.
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