Digital technology has made investing more accessible to the average person. In the same way that blockchains have led to new investment opportunities in Bitcoin et al, online investment platforms have opened the door to a variety of financial instruments. Commodities such as gold and oil are often the first thing new investors gravitate towards, as are stocks in companies like Amazon and Tesla. However, these aren’t the only investment opportunities. Exchange traded funds (ETFs) have become increasingly popular over the last 30 years.
These financial instruments evolved out of the public index mutual funds that launched in the 1970s. Various attempts to launch what we now call ETFs took place between 1989 and 1992, but it wasn’t until the S&P 500 Trust ETF launched in 1993 that it became a mainstream product. Barclays launched its own ETF in 1996 and Vanguard followed suit in 2001. Today, in 2021, there are more than 160 distinct issuers of ETFs. This recent growth is due, in part, to the rise of online investment platforms. Indeed, because ETFs allow investors to buy a single product that covers a large group of stocks or bonds, they’re seen as a stable edition to an investment portfolio.
For example, the S&P 500 tracks the 500 of the largest companies in the US. There are never any guarantees in the stock market, but the S&P 500 can be considered a relatively stable investment because the likelihood of these corporations going down all at once is low. Again, it’s not impossible. However, when you compare an ETF like the S&P 500 to penny stocks or cryptocurrencies, they’re a lot less volatile. This, in turn, can make them an ideal investment for new investors who, by and large, have found their way into the market via an online platform.
Given that ETFs are a potentially profitable option for investors, it pays to know the market. Indeed, with a little bit of knowledge and planning, it’s possible to give yourself the best chance of making a profit through exchange traded funds. So, with this in mind, here are three tips for investing in ETFs.
1. Understand the product you’re investing In
An ETF is a financial instrument that incorporates a collection of stocks or bonds focused on a specific industry or market. For example, QQQ tracks the NASDAQ 100, which primarily focuses on technology, biotechnology, and healthcare stocks. Therefore, if you’re interested in tech-related to these areas, this could be an ideal ETF.
2. Find the most suitable ETFs
Once you’ve found an ETF that tracks stocks/bonds in an area you’re familiar with or interested in, it pays to know who manages it, what the costs are, and what the average returns are. Going back to our QQQ example, it’s managed by US management firm Invesco. This ETF has $76 billion worth of assets under management (AUM), and the expense ratio is 0.20%.
In simple terms, this means this ETF has a total market value of $76 million. Additionally, 0.20% of the fund’s assets are used for administrative purposes (i.e. things such as operating fees). You need to know these things because, eventually, you’ll be comparing different types of ETFs to find the best deal. You might prefer a stocks ETF with a high AUM. In contrast, you might be more interested in thematic ETFs with low expense ratios. Ultimately, there are options that will allow you to find what works best with your investment strategy.
The point here is that you need to zone in on certain types of ETFs and look at their specifics. Larger ETFs with a high AUM value might be more stable. However, a smaller ETF might be more volatile but have a greater potential upside. Both can be good investments, but only if you do the necessary research beforehand.
3. Don’t overinvest
ETFs should be seen as a long-term proposition. That means you shouldn’t commit all of your capital at once. Dollar-cost average (DCA) is a strategy that takes the total amount to be invested and divides it into smaller chunks. For example, if you plan to invest $10,000, you need to break it down into smaller amounts. Let’s say you divide it into 12 equal amounts. This would allow you to invest $833.33 every month for a year.
Doing this helps you reduce the impact of volatility. In other words, some months you’ll invest when the price is high and some months it will be low. At the end of the year, you’re hoping that the average price you’ve paid is potentially profitable based on your analysis. DCA won’t guarantee you a profit. None of these tips will. However, if you can get the right products and manage your money wisely, ETFs can be a valid investment option.