One of the surest ways to generate wealth is to invest your money in the stock market. However, with numerous options, it may be difficult for newbie investors to choose which ones to invest in. One excellent entry point in investing in the stock market is to invest in exchange traded funds.
What are Exchange Traded Funds?
Exchange-Traded Funds or ETFs are companies that give investors an option to invest their money in a fund that invests in a portfolio of assets, bonds, and other stocks. ETFs companies are registered with the Securities and Exchange Commission (SEC) and are managed by professional investment advisers.
ETFs also allow potential investors to use their money to purchase different bonds and stocks simultaneously based on the preferences of the investors. For example, an investor may want to buy ETFs from Fortune 500 companies; if this is the case, then the money will be invested by the fund managers in several companies belonging to that list.
Are ETFs the same as Mutual Funds?
Many are confused about the difference between mutual funds and ETFs since the basic principle of investment between the two are very similar to each other. However, these two investments are different from one another.
Mutual funds offer investors the chance to pool their money in a fund that will invest in assets, bonds, and stocks where they can receive interest on their investment portfolio. Mutual funds can be purchased from a brokerage firm or directly from the issuer and purchased at a fixed dollar amount. However, you can only purchase mutual funds after the trading day has closed, and their net asset values have been calculated for the next trading day.
ETFs, like mutual funds, also allow investors to pool their money into a diversified portfolio of stocks. However, unlike mutual funds, ETFs can be purchased anytime during the trading day if the investors are willing to pay the current market values of the funds at the time of purchase. To simplify, ETFs are traded just like any other stock in the stock market, with prices fluctuating throughout the trading day.
The Basics in Investing in Exchange Traded Funds
It is best to understand these different concepts that are associated with investing in ETFs.
Active vs Passive ETFs. ETF investments come in two basic types. Passive ETF investments, also known as index funds, use a system to track and match the performance of a stock index. The main purpose of passive ETFs investments is to match the performance of a specific index. On the other hand, active ETF investments use portfolio managers to beat the performance of a specific index.
Charges. Investors will be charged fees when they invest in ETFs; these charges are called an expense ratio. Expense ratios will give investors an idea of how much they are going to pay for every investment. Therefore, it is best to look for ETF investments with a low expense ratio. For example, investment has a 5% expense ratio means that investors will be charged five per cent of the total value of investments. So, when put into numbers, for an investment of $100, you will have to pay $5 in fees.
Dividends and DRIPs. Just like any investment, your money will earn if your investment portfolio is performing. The earnings are called dividends which you can get in the form of cash. Likewise, you can reinvest your dividends from exchange traded funds through a dividend’s reinvestment plan or DRIP.
There is always a risk when you invest your money in stocks. However, just like any other investment, the more you know about what you are investing in, the safer your investment.
