Passive Investing: Hands-Off Etf Strategies

Exchange-traded funds (ETFs) are an excellent entry point for new investors into the stock market. They are a collection of securities that trade on an exchange just like a stock. ETFs are a low-cost, low-effort, and diversified investment option.

ETFs are ideal for investors who want a hands-off approach to investing. They are passively managed, meaning they aim to replicate the performance of a specific index like the S&P 500 or the Dow Jones Industrial Average. This means you don't need to actively pick and choose stocks, reducing the time and effort required.

To start investing in ETFs, you need to open a brokerage account, either through an online broker or a robo-advisor. You can then decide on the type of ETF you want to buy, such as those that track a specific index or market sector. Finally, you can place your order by specifying the number of shares and the order type.

ETFs are a great way to build a diversified portfolio with minimal effort, making them a popular choice for investors seeking a simple and effective investment strategy.

Open a brokerage account

To start investing in ETFs, you'll need to open a brokerage account. This is a prerequisite for buying ETFs and will be the account in which your ETFs are held. You can open a brokerage account with an online broker for free with little effort and then invest money in ETFs.

In recent years, so-called 'neobrokers' have become increasingly popular. These are online brokers that often charge very low or even no fees for buying and selling ETFs and also offer ETF savings plans at the best rates.

When deciding on an online broker, you can use an online broker comparison tool to help you decide. You can then open a custody account via the app or the broker's website. The whole process doesn't take very long, and in many cases, you can easily identify yourself using video identification.

Once you've completed all the formalities, you'll need to wait a few days for your account to be opened. After that, you can transfer money directly into your custody account and invest in ETFs immediately.

Choose your first ETFs

Now that you've opened a brokerage account, it's time to choose your first ETFs. Here are some things to keep in mind:

• Passive vs. active ETFs: Passive ETFs (index funds) track a stock index like the S&P 500, while active ETFs hire portfolio managers to invest their money with the goal of beating the index's performance. Passive ETFs are generally cheaper and a better option for beginners.
• Expense ratios: ETFs charge fees known as expense ratios, which are listed as an annual percentage. Lower expense ratios mean lower costs for investors, so this is an important factor to consider.
• Diversification: ETFs are a great way to diversify your portfolio as they allow you to buy multiple stocks or bonds from different sectors or industries all at once. This reduces your risk by spreading your investments across various assets.
• Investment goals: Think about what role you want your ETF to play in your portfolio. Are you looking for a foundational building block or specific exposures to fill gaps? This will help you decide between, for example, a broad market index ETF or a sector-specific ETF.
• Performance: While past performance doesn't guarantee future results, it can give you an idea of how well the ETF has achieved its goals. Compare the ETF's performance to its benchmark to see how it has performed relative to its underlying index.
• Cost: ETFs are known for their low costs, but it's important to consider the expense ratio and any other fees or commissions associated with buying and selling. Look for commission-free ETFs to keep costs down.
• Tax efficiency: ETFs can be tax-efficient, but it's important to understand the tax implications, especially if you're investing in a taxable account. In the US, for example, gains from selling an ETF are taxed according to capital gains tax rules, and dividends may also be taxable.
• Minimum investment: ETFs generally have low minimum investment requirements, making them accessible to a wide range of investors. However, you'll need at least the current price of one share to get started.
• Vanguard S&P 500 ETF (VOO): Tracks the S&P 500, which is often considered a benchmark for the overall US stock market.
• Schwab U.S. Mid-Cap ETF (SCHM): Focuses on midsize US companies between those in the S&P 500 and Russell 2000.
• Vanguard Russell 2000 ETF (VTWO): Invests in smaller US companies within the Russell 2000 small-cap index.
• Schwab International Equity ETF (SCHF): Focuses on larger non-US companies.
• Vanguard High-Dividend ETF (VYM): Invests in stocks that pay above-average dividends, mostly large-cap companies.

Remember to do your own research and choose ETFs that align with your investment goals and risk tolerance. Diversification is important, so consider investing in ETFs from different sectors and market capitalizations.

Let your ETFs do the hard work

Once you've done your research, chosen your ETF and made your purchase, it's time to let your ETFs do what they were designed to do: produce excellent investment growth over long periods.

ETFs are generally designed to be maintenance-free investments. It's important to resist the temptation to check your portfolio too often and make emotional, knee-jerk reactions to major market moves. The average fund investor significantly underperforms the market over time, and over-trading is the main reason.

ETFs are already well-diversified, so you don't need to worry about creating diversification within your portfolio. This means you can avoid the hassle and expense of doing significant research and purchasing shares in many different companies.

ETFs are also more tax-efficient than mutual funds. With ETFs, you don't have to pay capital gains taxes throughout the lifetime of your investment. This is because ETFs generally incur capital gains taxes only when you sell the investment.

ETFs are ideal for anyone who wants a low-cost, low-effort, and diversified portfolio.

Compare ETF options

When comparing ETF options, there are several factors to consider. Firstly, ETFs can be categorised into passive and active ETFs. Passive ETFs aim to replicate the performance of a broader index, such as the S&P 500, while active ETFs hire portfolio managers to actively invest their money with the goal of beating an index's performance. Active ETFs tend to be more expensive.

Secondly, ETFs can be further classified by their focus. There are industry or sector ETFs, which focus on a specific sector or industry, such as energy or healthcare. There are also commodity ETFs, which invest in commodities like gold or crude oil; currency ETFs, which track the performance of currency pairs; and country ETFs, which track the primary stock indexes of foreign countries but are traded in the US.

When comparing specific ETFs, it is important to look at their performance, fees, holdings and ESG (environmental, social and governance) metrics. Some of the fees to consider include expense ratios, management fees, transaction costs and redemption fees. It is also important to note that ETFs are generally more tax-efficient than mutual funds, as buying and selling occur through an exchange.

Additionally, it is worth considering the level of diversification offered by an ETF. While ETFs are inherently more diversified than individual stocks, some ETFs may be highly concentrated in specific sectors or types of securities. Therefore, it is important to assess the distribution of assets across different sectors and market capitalisations when comparing ETFs.

Finally, it is crucial to evaluate your own investment goals, risk tolerance and level of expertise before selecting an ETF. For example, if you are a beginner, a low-cost index ETF that tracks a broad market index like the S&P 500 might be a suitable option. On the other hand, if you are more experienced and willing to take on more risk, you might consider an actively managed ETF or an ETF that focuses on a specific sector or industry.

Execute an order

Now that you have chosen the ETF(s) you want to invest in, it's time to execute an order. Here are the steps you need to take:

• Enter the ticker symbol: The ticker symbol is a series of letters that represent the security you want to buy. For example, if you're interested in the Vanguard S&P 500 ETF, the ticker symbol is "VOO".
• Understand the ask and bid price: The ask price is the lowest price the seller is willing to accept for the ETF, while the bid price is the amount a buyer is willing to pay.
• Determine the quantity: Decide on the number of shares you want to purchase. For example, if you want to spend $200 and the cost of the ETF is $40 per share, you can buy 5 shares ($200 / $40 = 5 shares).
• Choose the order type: The two most common order types are market orders and limit orders. A market order allows you to buy the ETF immediately at the current market price, while a limit order lets you specify the price you're willing to pay, and the order is only fulfilled when that price or a lower one is reached.
• Set the time in force: This defines how long your order will remain active before it expires.
• Review the order details: Before placing the order, carefully review all the information, including the ticker symbol, order type, quantity, and any other relevant details. Make sure there are no typos or mistakes that could impact your trade.
• Place the order: Once you're confident that all the information is correct, you can proceed to place the buy order. Congratulations! You've just purchased your first ETF.

Remember, it's important to do your research and understand the risks involved before investing. Additionally, consider seeking advice from a financial professional who can guide you based on your specific circumstances.

Frequently asked questions