How to Invest in ETFs

Introduced in 1993, Exchange-Traded Funds or ETFs, as they are commonly known today, have steadily gained attention and momentum among investors over the years. ETFs are a unique investment product that combine the benefits of both stocks and mutual funds, offering a blend that is hard to find elsewhere.

One of their biggest draws is diversification. A single ETF can give you exposure to hundreds of different investments at once, making it easier to gain exposure to a wide variety of assets and spread your risk.

That said, before you dive in headfirst, you need to understand a few things, including how to invest in ETF funds, their benefits and drawbacks, and everything in between. Here’s a complete ETF investing guide to help answer all your questions.

What are ETFs?

An ETF is a basket of securities that holds a mix of investments, such as stocks, bonds, cryptocurrency, short-term cash instruments, or a blend of these. All of these investments are bundled together into a single tradable product. Just like a stock, you can buy or sell it on an exchange. But stocks are not the only asset they resemble.  

ETFs work a lot like mutual funds in one key way. They pool money from many different investors and put it to work across a diversified set of holdings. However, the similarity mostly ends there. Mutual funds price and trade only once a day, after the market closes. ETFs, on the other hand, trade all day long, with prices moving up and down, just like any individual stock you would find on a stock exchange. When you buy a share of an ETF, you own a piece of that fund’s entire portfolio and are entitled to a share of the income it generates.

ETFs in the U.S. typically have to register with the Securities and Exchange Commission (SEC) as either a unit investment trust or an open-end investment company. All the investments an ETF holds together are called its portfolio, and a professional, SEC-registered investment adviser usually manages it.  

An ETF can offer dividends and capital gains. Additionally, its market price can also increase, which can help you lock in a profit. If the fund holds stock dividends or bond interest, it is passed on to investors as dividend payouts. An ETF may also sell appreciated securities at a profit and distribute the net gains to investors annually. If the overall value of the ETF’s portfolio increases, it pushes up its Net Asset Value (NAV) and, in turn, its share price.  

ETFs trade on national stock exchanges, such as Nasdaq or the New York Stock Exchange (NYSE), among others, at whatever price the market sets. This price will not always match the fund’s NAV exactly. Depending on market conditions, an ETF can trade at a slight premium or discount relative to its actual underlying worth. So, the price you pay when buying or receive when selling might land a little above or below the NAV.  

Now that you know a bit about how ETFs work, let’s move on to the next section – how to invest in ETFs.

How to start investing in ETFs?

1. Create an account on a brokerage platform

Before you can buy your first ETF, you will need a brokerage account. You can go through an online broker or a traditional broker-dealer. Some robo-advisors also offer ETFs. Select any of these as per your choice.  

Once your account is set up and funded, you can search for the ETF you want and place a buy or sell order like you would with any stock.

2. Select a suitable ETF for your financial needs and financial goals

Your brokerage account may give you access to several different types of ETFs, so it can help to reach out to a financial advisor for expert guidance before you dive in. Here are the main types of ETFs you need to know:

• Actively managed ETFs: Instead of following an index, a portfolio manager actively picks the underlying securities. These ETFs may come with higher fees.
• Passive ETFs: These simply track a broader index, like the S&P 500, or a specific sector or trend.
• Bond ETFs: These generate regular income from underlying government, corporate, or municipal bonds. However, unlike individual bonds, they never actually mature.
• Commodity ETFs: These invest in commodities, such as raw materials like gold or crude oil.
• Currency ETFs: These track currency pairs and let you speculate on exchange rates.
• Sector ETFs: These invest in a basket of stocks focused on one industry. For example, energy. They give you diversified exposure within that space.
• Bitcoin ETFs: These ETFs hold actual Bitcoin and allow you to invest in cryptocurrency.
• Ethereum ETFs: These let you gain exposure to Ether, Ethereum’s native token, without holding the cryptocurrency directly.
• Leveraged ETFs: These aim to multiply returns (2x or 3x) on an underlying index.
• Inverse ETFs: These aim to profit when stocks decline, using derivatives instead of traditional short selling.  

Evaluate your risk appetite and risk horizon before selecting a suitable ETF. You can also invest in different types of ETFs to further diversify your portfolio.   

3. Check the ETF’s prospectus and shareholder report

You can review an ETF’s prospectus and most recent shareholder report for free on the SEC’s website and the fund’s website. These can help you determine whether the ETF suits your needs. It may be wise to check these before you invest to better understand your chosen funds.  

4. Place the trade order

Once you have zeroed in on the ETF you want, the next step is to place the trade. You do this the same way you would with any stock. From there, all that is left to do is sit back. If all goes well, you can potentially watch your investment grow over time. You may review your ETF portfolio to rebalance from time to time, if needed.  

ETF investing guide – Pros and cons  

While ETFs are generally regarded as a good investment option, they come with their own pros and cons, like any other asset class. Some aspects work in your favor, while others may not, so it helps to understand exactly what you are getting into before you invest.  

Pros of investing in ETFs

• Low costs: You pay an expense ratio when investing in an ETF. The expense ratio covers the cost of operating and managing the fund. Since most ETFs simply track an index, they tend to have low expenses, which can help improve your returns. You can also buy ETFs commission-free through most brokers. Overall, they may be more affordable than mutual funds over time.
• Instant diversification: A single ETF can spread your risk across multiple asset classes, sectors, industries, and instruments, all in one purchase. This instant diversification helps cushion your portfolio against ups and downs.
• Multiple types to choose from: With so many categories of ETFs available, you can pick the ones that align with your specific goals and build a portfolio tailored to your goals. From broad market index funds to sector-specific, bond, commodity, and even crypto-focused options, you can easily construct a well-rounded portfolio that reflects your financial needs.
• Risk management: Between the natural diversification ETFs offer and the fact that many are managed or overseen by financial professionals tracking an underlying index, ETFs can help keep your overall portfolio risk under control.  
• Beginner–friendly: Taken together, advantages such as lower costs, instant diversification, a wide variety of options, and lower risk make ETFs a particularly appealing asset for new investors. You do not need market expertise or a large amount of capital to get started. They can suit everyone, including people just beginning to build their investment portfolios.  
• Liquidity: Since ETFs trade on the open market just like stocks, you can buy or sell your shares at the current market price any time the market is open. This gives you far more flexibility than many other investments that only settle once a day.

Cons of investing in ETFs

• Higher fees for actively managed funds: While ETFs are generally low-cost, actively managed ETFs tend to charge higher fees than their passive counterparts. These costs are deducted directly from the fund’s NAV, so you pay them indirectly rather than as a separate line item. Since fees and expenses vary widely from fund to fund, you must understand exactly what an ETF charges and how that could eat into your returns over time.
• Diversification is not guaranteed across the board: While ETFs offer diversification, how much you actually get depends on the specific fund. Sector-focused ETFs, for instance, only give you exposure to that one segment. The same applies to specialized funds like Bitcoin ETFs. So you may not be as diversified as you think.
• Lack of liquidity: Some ETFs do not trade very often. This lower trading volume can make it harder to buy or sell shares quickly.  
• Possible tracking errors: Passive ETFs are designed to mirror the performance of a market index, but they do not always do so perfectly. When an ETF’s returns drift from the index it is meant to track, it creates tracking errors that ultimately affect your overall returns.  
• Limited personalization: Once you invest in a particular ETF, you are locked into that fund’s predetermined mix of holdings. The fund manager decides what to include or exclude, based on the fund’s perspective. You, as an individual investor, cannot customize which individual securities you invest in.  

How much should you invest in an ETF?

There is no universal answer here. Some investors aim to put away around 10% to 15% of their paycheck. You could also invest a fixed amount regularly, as much as your budget allows, rather than a percentage of income. But ultimately, the right amount for you will come down to your financial situation, goals, time horizon, and risk tolerance.  

However, investing regularly in ETFs can help. No matter the amounts, investing a consistent sum at regular intervals helps you take advantage of dollar-cost averaging. This can help smooth out the impact of market volatility over time, since you end up buying more shares when prices are low and fewer when prices are high.  

You can speak with a financial advisor to determine a suitable investment amount for you.  

Consult a financial advisor to know how to invest in ETFs

ETFs can offer plenty of benefits, like diversification, liquidity, risk management, and more. And since they trade conveniently on the stock exchange while still being professionally managed like mutual funds, they can be a great option to explore even if you are a novice investor. That said, there are some cons worth keeping in mind, and getting a professional’s take can go a long way toward helping you decide whether and how ETFs fit into your overall financial picture. Speaking with a financial advisor can help. If you are not sure where to start, our financial advisor directory can help you find a qualified advisor near you.  

Frequently Asked Questions (FAQs) about how to invest in ETF funds

1. Can I use ETFs for short-term goals?

Yes, you can. ETFs don’t have a lock-in period, and certain types, like bond ETFs, may suit shorter-term goals. That said, it is important to understand the risks and typical investment horizon associated with the specific type of ETF you choose, so you can get the most out of it. Speaking with a financial advisor can help you choose the right ETFs for your time horizon.  

2. Are ETFs better than mutual funds?

It depends on what you are looking for. Both offer professional management and diversification, but ETFs trade like stocks throughout the day, while mutual funds only price once daily. The better choice really comes down to your personal needs, trading preferences, and investment style.

3. Can I invest in ETFs in my 20s?

Yes, you can. ETFs are a good option for beginners because they offer built-in diversification and risk management. Just make sure to pick the right ETFs that align with your specific goals and time horizon. And, if you have any doubts, reach out to a financial advisor for guidance.