How to build a portfolio and invest in ETFs for beginners – The Average Joe

    How to build a portfolio and invest in ETFs for beginners

    Victor Lei — Head of Research

    August 16, 2021

    How to build a portfolio and invest in ETFs for beginners

    August 16, 2021

    The first step to building any investment portfolio should be learning how to invest in ETFs (exchange-traded funds) — the low cost, low effort and simple way of investing.

    Building a portfolio with ETFs is one of the best ways for investors of all levels to achieve their financial goals. ETFs are among the most influential innovations in the financial industry in the past few decades, disrupting one of the most popular investments among retail investors, mutual funds.

    • ETFs are similar to mutual funds except they often have lower fees, are more convenient and they can provide similar or better returns.

    ETFs have also created a whole new way for investors to manage their own money. In this guide, we teach you how to invest in ETFs and show you the steps to building a portfolio with ETFs — taking advantage of one of the simplest ways to get into the stock market.

    Contents: How To Invest In ETFs?

    • ETFs for Beginners: What is an ETF (Exchange-Traded Fund)?
    • How to invest in ETFs and build a portfolio with them?
    • How much should investors allocate toward ETFs?
    • How to invest in ETFs that focus on specific industries/themes?
    • Investing in ETFs for beginners: Popular ETFs to get started

    Investing in ETFs for Beginners: What is an ETF (Exchange-Traded Fund)?

    An ETF is an investment that contains a basket of different assets (e.g. stocks, bonds, crypto, cash, etc.). Like a stock, it can be bought and sold on the stock market.

    Compared to stocks, investing in ETFs have several benefits that make them better suited for most retail investors:

    • Diversification: By buying an ETF, investors spread their risk among different several companies or assets — which protects them even if one of the assets were to lose all its value.
    • Low annual fees: Compared to mutual funds, ETFs have a lower fee.
    • Low maintenance: Most ETFs are designed for investors to be able to hold them for a long period of time as a passive investment.
    • Simplicity: ETFs are easier to get started with than stocks or other more complex investments.

    ETFs have evolved rapidly in the past few decades, and ETFs tracking many different types of investments have been launched. For example:

    • The CI Galaxy Bitcoin Fund (TSE:BTCX) is an ETF that gives investors exposure to Bitcoin.
    • The First Trust NASDAQ Cybersecurity ETF (NASDAQ:CIBR) is an ETF that gives exposure to a basket of cybersecurity stocks.

    There are thousands of ETFs that track different indexes or baskets of stocks. Some are focused on foreign countries, sectors, company sizes, asset classes and more. By investing ETFs, investors can benefit from diversification, low fees and the ability to invest in different themes, countries or sectors in a lower-risk way.

    Investing in ETFs For Beginners: Understanding Stock Market Indexes

    To understand ETFs, you’ll need to have a basic understanding of stock market indexes, which is a measure used to track the stock market’s performance. These indexes are usually categorized by sectors, geographies or company sizes.

    Some of the most common indexes are:

    • The S&P 500 — an index that tracks the performance of 500 of some of the largest companies in the US.
    • The NASDAQ — an index that tracks the performance of all the stocks listed on the NASDAQ stock exchange — heavily geared towards tech stocks.

    Think of these indexes as a scoreboard — tracking the performance of the stocks in that sector. This is why you’ll often find the tickers for the S&P 500 and NASDAQ in most investment platforms and financial publications.

    The S&P 500 is a commonly used benchmark for performance in the US — this is an important index in the market, and you’ll often find this mentioned in financial media.

    There are also smaller, lesser-known indexes like the BVP Nasdaq Emerging Cloud Index — which tracks the performance of emerging cloud software companies.

    Investing in ETFs for Beginners: Why Are Indexes Important To Understanding ETFs For Beginners?

    ETFs are divided into active and passive ETFs.

    • Passive ETFs often replicate the performance of a stock market index or a basket of stocks.
    • Active ETFs have a team of portfolio managers and analysts constantly deciding what stocks to buy, hold or sell in the ETF.

    Passive ETFs typically have a lower fee. They’re easier to manage (no need for a team of analysts and have lower portfolio turnaround (selling and buying of positions in a portfolio). The largest and most common passive ETFs are:

    • The SPDR S&P 500 ETF Trust (NYSE:SPY) — 0.095% expense ratio.
    • The iShares Core S&P 500 ETF (NYSE:IVV) — 0.03% expense ratio.

    Both replicate the returns of the S&P 500, but the most significant difference is the companies that created them and the expense ratio (annual fee on the ETF). Investors may choose to hold either one of these ETFs instead of owning both as they give exposure to the S&P 500.

    How To Invest And Build A Portfolio With ETFs?

    ETFs are traded on stock exchanges — bought and sold just like you would with a regular stock. Compared to mutual funds, ETFs have many benefits:

    • ETFs can be bought at any time during market hours while mutual funds can typically only be bought once a day (after market hours).
    • ETF trades can be easily entered by the investor online with a trading account but in most cases, mutual funds can only be bought by a broker or financial advisor.
    • Investors can see the value of ETFs constantly changing in their trading app whereas the value of mutual funds is calculated once a day after the market closes.

    ETF trades are executed just like you would with stock, and there are no minimums with investing in ETFs — investors can choose to buy a single share in an ETF.

    Trading apps like Public and M1 Finance offer ways to discover ETFs in different investment themes like Gaming & eSports or artificial intelligence-related ETFs. These apps are also great tools to invest in ETFs for beginners.

    How Much To Allocate When Building A Portfolio With ETFs?

    It’s known in the industry that most professional fund managers cannot consistently beat the S&P 500 — which returned an average return of 9.25% annually in the past 150 years. Beating the S&P 500 benchmark is difficult even for professionals, which becomes even harder for retail investors.

    For this reason, famous investor, Warren Buffett, advocates for retail investors to place their money in index funds that track the S&P 500.

    But despite having trouble beating the S&P 500 market average, retail investors still choose to buy individual stocks to beat the market average. If an investor decides to buy individual stocks, it’s often good to allocate a portion of their investment portfolio and invest in ETFs.

    Ultimately, the amount an investor should allocate towards ETFs depends on these factors, which are essential to learning how to invest with ETFs:

    • Risk tolerance: The lower your risk appetite, the more the investor should allocate towards ETFs.
    • Amount of time dedicated to investing: The less time available to research and analyze companies, the more the investors should allocate towards ETFs.

    By investing in ETFs, investors are exposed to less risk than buying an individual stock. Investors can get by spending less time researching when they purchase an index fund that diversifies between hundreds of companies.

    How To Invest In ETFs That Focus On Specific Industries And Themes?

    Some ETFs offer the best of both worlds — investing on autopilot (passive investing) and being more active with selecting investments in different trends/industries.

    Investors can bet on different trends, themes or sectors with thematic ETFs — a type of ETF that investments in a particular basket of assets. These themes include:

    • Country-specific ETFs — i.e. Europe, China, India, etc.
    • Commodity-specific ETFs — i.e. gold, silver, oil, etc.
    • Sector-specific ETFs — i.e. sports betting, gaming, clean energy
    • Digital-currency ETFs — i.e. Bitcoin, Ethereum

    ETFs aren’t limited to investing in stocks. In the case of the CI Galaxy ETF (TSX:BTCX), the ETF holds Bitcoin, which gives the investor exposure to the asset. The ETF tracks the performance of Bitcoin and is used as an alternative to directly buying Bitcoin.

    Name Ticker Theme 5-Year Annualized Return Expense Ratio
    Amplify Online Retail ETF NYSE:IBUY E-commerce 36.05% 0.65%
    CI Galaxy Bitcoin ETF TSX:BTCX Bitcoin N/A 0.40%
    Global X Blockchain ETF NASDAQ:BKCH Blockchain N/A 0.50%
    iShares Global Clean Energy ETF NASDAQ:ICLN Clean Energy 24.17% 0.42%
    The Global X Cloud Computing ETF NASDAQ:CLOU Cloud Computing N/A 0.45%

    *Returns as of Aug 14, 2021

    Qualities of thematic ETFs:

    • Tend to have a higher expense ratio compared to the SPY’s 0.095% expense ratio — nearly 4-5x more.
    • Require more research compared to investing in a broader ETF like an S&P 500-based ETF.

    Compared to an ETF that tracks the S&P 500, which gives the investor exposure to over 500 different companies, the number of holdings in a thematic ETF tends to be less. It is concentrated in one theme/sector — which makes them riskier:

    • The Amplify Online Retail ETF invests in over 70 different companies
    • The CI Galaxy Bitcoin ETF only holds one asset, Bitcoin.

    Investors should check the number of holdings and assets in each to ensure that the ETF is diversified enough for the investor’s risk profile when investing in ETFs.

    Investing In ETFs For Beginners: Popular ETFs To Get Started

    In the US, there are over 2,204 ETFs in US, and thousands more globally and hundreds more launched each year, which can make it challenging to find the right ones.

    Listed below are some of the most common and popular ETFs that give investors a good starting point in building a portfolio with ETFs:

    How to build a portfolio and invest in ETFs for beginners

    Holdings and returns listed below are as of Aug 14, 2021.

    The iShares Core S&P 500 ETF (NYSE: IVV)

    This ETF is one of the largest ETFs is common among most investment portfolios — providing the investor exposure to 500 of the largest US companies in the most prominent sectors. The IVV is one of the most common investments to get exposure to a growing US economy.

    • Ticker: IVV (NYSE)
    • Holdings: 507 companies
    • Expense ratio: 0.03%
    • Annualized performance: 17.61% (5-year), 14.78% (10-year)

    The Invesco QQQ ETF (NASDAQ:QQQ)

    QQQ tracks the performance of the NASDAQ-100 index — a list of the largest domestic and international non-financial companies. The index has a heavy weighting on tech companies, making it a standard benchmark used for the tech sector’s performance.

    • Ticker: QQQ (NASDAQ)
    • Holdings: 102 companies
    • Expense ratio 0.20%
    • Annualized performance: 27.97% (5 year), 21.26% (10 year)

    Learn more: Is the QQQ ETF right for you?

    ARK Innovation ETF (NYSE:ARKK)

    ARKK is an actively managed ETF run by a popular investor, Cathie Wood and her firm ARK Invest — which is opportunistically buying and selling stocks in the ETF.

    ARKK focuses on investing in companies innovating in the following areas: genomic revolution, industrial innovation, next-generation internet and fintech innovation.

    • Ticker: ARKK (NYSE)
    • Holdings: 49 companies (constantly changing given the active nature of the ETF)
    • Expense ratio: 0.75%
    • Annualized performance: 48.55% (5 year), 34.2% (since inception 10/31/2014)

    Learn: How Cathie Wood built ARK Innovation into the best-performing ETF of 2020

    Are you ready to go beyond investing in ETFs and into stock? Graduate from our ETFs for beginners guide to our guides on picking stocks:

     

    Chapters: The Beginners Guide to Investing

    1. Guide: How to Learn the Stock Market Basics

    2. Best Stock Investing App for Beginners

    3. How to Pick Stocks for Long Term Investment

    4. How to Build a Portfolio and Invest in ETFs for Beginners

    5. When Should You Sell a Stock for Profit: Top 5 Reasons

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