Many beginning investors face two key questions when determining where to invest their hard-earned dollars: how much disposable or investable assets are available and which investments to choose when building a portfolio. Determining how much investable capital remains after accounting for everyday living expenses is relatively straightforward for most individuals: income from all sources - living expenses = disposable or investable capital. Selecting investment vehicles is an entirely different proposition.
To get into the investing game on your own, you will first need to do some research. Be prepared to learn new vocabulary and discover lots of advice and information on investing. At some point, as a newer investor, you must select the class of assets that best suits your investment needs. In other words, what percentage of your investable assets should be allocated toward bonds instead of stocks, or bonds instead of real estate? Once you determine your asset allocation, then you have to determine which type of investment accounts to set up: a brokerage and/or a retirement account. Investments are either tax-deferred or tax-exempt in retirement accounts, whereas all gains and losses are a yearly taxable event in a regular brokerage account.
As you have probably gleaned so far, these are serious financial decisions that shouldn’t be taken lightly. For investors who wish there was an easier, cost-efficient way to invest that still allowed customization, exchange-traded funds (ETFs) may be the answer.
How ETFs Work
ETFs are investment funds comprised of stocks, bonds, commodities or real estate assets that can be purchased daily on various open exchanges. One of the benefits ETFs have over other similar investments is high liquidity and built-in diversification. Liquidity, which is the ease with which a security can be bought and sold, rises when there are several buyers and sellers. ETFs may appear similar to mutual funds, but the latter seldom trades that much volume daily. Furthermore, while mutual funds can only be purchased at certain times in the day, ETFs can be bought and sold at any time in the trading day. Typically, ETFs trade around net asset value.
Diversification is another buzzword or tenant of investing that is familiar to most people. Generally, ETFs are highly diversified investments with many assets of the same class or even a mix of stocks and bonds. As a result, rather than going out and researching stock sectors and recommended asset allocations, you can simply find an ETF that meets your investment needs. For example, if you have an interest in just buying an ETF that mirrors the overall market indices, you could purchase the SPDR S&P 500 ETF (SPY). SPY is also already pre-weighted, so the largest companies make up a larger portion of the investment fund than smaller ones. This built-in feature alleviates concerns about appropriately balancing investments according to company size. (For more, see: 5 Reasons Why ETFs Work for Young Investors.)
Motif’s Take on ETFs
The relatively new kid on the do-it-yourself investing block is Motif Investing. Akin to ETFs, Motif’s investment options exist as baskets of stocks that mirror certain themes or motifs. For example, let’s say you believe that clean eating is the way of the future and you expect it to grow significantly. Based on this, you can select a basket of stocks that specialize in the production, marketing, distribution and selling of healthy and organic foods. Motif gives investors the ability to build a diversified set of leading companies that are expected to lead in their respective industries. Another advantage of Motif is very low investing fees relative to comparable investments. Mutual funds typically charge a yearly fee along with an expense ratio, whereas ETFs and motifs only incur transaction fees and, unlike mutual funds, don’t penalize investors for early redemptions. (For more on Motif, see: Motif Impact Investing Review.)
The Bottom Line
Investing can be a daunting task. Assessing your overall financial situation and then selecting the right investments given a variety of factors requires some thought. Exchanged-traded funds are a good choice for beginning investors given their ease of transaction, high liquidity and relatively low cost of ownership. ETFs are worthy for consideration on taxable as well as tax-advantaged accounts. As a player in the do-it-yourself investing space, Motif investing helps investors with a more secular or focused investment objective find certain ETF-like motifs that contain worthy investment choices. Overall, selecting an ETF as a core investment vehicle makes sense for a lot of investors.