With the diversification of the investment market, ETFs (Exchange Traded Funds) have gradually become an important investment tool for investors, especially novices. ETFs have become the first choice of more and more investors around the world for their advantages such as low cost, good liquidity and risk diversification .
However, despite the obvious advantages of ETFs, it is still a challenge for many novices to get started and choose the right ETF. This article will explain in detail how novices can invest in ETFs, helping you understand the basic concepts of ETFs, how they work, and how to buy them.
What is an ETF?
ETFs are exchange-traded open-end index funds that allow investors to buy multiple stocks, bonds, or other assets at once. Investors buy ETF shares and use their funds to invest according to specific goals. For example, if an investor buys the S&P 500 ETF, their funds will be invested in proportion to the 500 companies in the index.
The Difference Between ETFs and Mutual Funds
How do ETFs differ from mutual funds, given that the underlying principles are the same? The main difference between these two investment vehicles is how you buy and sell them.
Mutual funds are priced once a day, and investors invest a fixed amount. Purchase channels include brokerage firms or issuers. Transaction confirmation is not immediate and usually takes T+1 working days or longer.
ETFs are traded in the same way as stocks. Investors can choose the number of shares to purchase, and prices fluctuate in real time during the trading day, and transactions are completed in real time.
Key ETF Knowledge
There are some important concepts you need to understand before buying your first ETF.
Types of ETFs: ETFs are divided into passive and active types.
Passive ETFs are index funds that aim to track a specific index, with a portfolio similar to the index's constituent stocks and low management costs. For example, the S&P 500. Passive ETFs hope to match the performance of the index.
Active ETFs are actively managed by portfolio managers in an attempt to outperform the market and have higher management fees.
Expense rate: ETFs charge fees, called expense rates, which are expressed as an annual percentage. For example, if you invest 100,000 yuan in an ETF with an expense rate of 0.5%, you will pay 500 yuan in fees each year. When choosing an ETF, investors should compare expense rates and give priority to products with lower expense rates, all other things being equal.
Dividend and reinvestment strategy: Most ETFs pay dividends, and investors can choose to pay in cash or purchase more shares through a dividend reinvestment plan (DRIP). DRIP can exert compound interest effects. For example, if you initially invest 1,000 shares at $10 per share and a dividend rate of 4%, and choose to reinvest, you can buy 40 shares with dividends in the first year, and the dividends in the second year are calculated based on 1,040 shares, and the asset scale is expanded.
Tax considerations for ETFs: Investing in ETFs in a standard brokerage account may generate taxable income from capital gains and dividends received from sales, and the capital gains tax rate varies depending on the holding period. There are tax advantages to investing in ETFs through an individual retirement account (IRA). Traditional IRA accounts do not require capital gains and dividend taxes before funds are withdrawn, and taxes are paid when they are withdrawn. Roth IRA investments are tax-free when they meet the conditions for income and dividends.
Of course, if you invest in ETFs through an IRA, you don't have to worry about capital gains taxes or dividend taxes. In a traditional IRA, the funds in the account are considered taxable income only after they are withdrawn, while Roth IRA investments are not taxed at all in most cases.
The capital threshold for investing in ETFs
ETFs usually do not have strict minimum investment amount requirements and are traded on a share basis. When fractional share trading is not supported, you only need to prepare one share of capital to invest. Some brokers provide fractional share trading services to lower the investment threshold.
Pros and Cons of ETFs
Advantages of investing in ETFs
Diversification and low cost: ETFs can achieve diversified asset allocation at low cost, have low management fees, and improve long-term investment returns.
Market tracking and transparency: Many ETFs track market indices, and the index compilation rules are transparent, making it easier for investors to make decisions.
Liquidity: ETFs are listed on stock exchanges and traded in a similar way to stocks. They have high liquidity and investors can buy and sell them at any time to adjust their investment portfolios.
Simplified fixed income investment: Bond ETFs invest in a variety of bonds to diversify credit risk and simplify the fixed income asset allocation process.
Disadvantages of Investing in ETFs
Return potential: ETF returns are close to the market average, and the potential for obtaining super-high returns is lower than individual stock investments.
Transaction costs: ETFs are subject to management fees and trading commissions, and frequent trading will erode investment returns.
Practical steps for beginners to invest in ETFs
Step 1: Open a Brokerage Account
Newbies who want to invest in ETFs need to choose a broker to open a brokerage account so that they can buy and sell ETFs. Currently, many online brokers have launched commission-free stock and ETF trading services. When choosing, investors should consider the broker's platform functions, research report quality, customer service level, etc. If you are a novice, it may be a good idea to choose a broker that provides rich educational resources.
Step 2: Screen your first ETF
For beginners, passive index funds are usually the ideal choice. Passive index funds have lower expense ratios than actively managed funds, and in the long run, most actively managed funds have difficulty outperforming the benchmark index. Newbies can give priority to ETFs that track broad-based indexes.
Step 3: Follow long-term investing principles
ETFs are suitable for long-term investment, but novices often have a bad habit of checking their portfolios too frequently and reacting emotionally and knee-jerk to major market movements. In fact, the performance of ordinary fund investors often lags behind the market over time, and overtrading is the main reason for this phenomenon. Long-term holding of ETFs can smooth market fluctuations and realize asset appreciation. Investors can regularly evaluate their portfolios and make appropriate adjustments.
Therefore, once you buy some ETF shares, the best advice is to leave them alone and let them do what they are supposed to do, and they may produce excellent investment growth afterwards.
Conclusion
As a low-cost, flexible and efficient investment tool, ETF is suitable for beginners to accumulate wealth in the long term. By choosing the right ETF, diversifying investments, regularly monitoring and controlling risks, beginners may achieve a steady return on investment in the ETF market. Whether through market indices, industry sectors or international markets, ETFs provide investors with a variety of investment options to help investors move towards financial freedom .
