There are plenty of ways that show you are entering the responsible grown-up life. It could be when you buy your first car or home. For others, it could be when they entered college. For those who love finance, it may be when they start making investments. Investing your hard-earned money in the market can be daunting. With so many public companies, whose stocks should you start buying first? What about the sector? Should you go for healthcare, tech, finance? Despite the fact that you are a rookie or a veteran in the trading and investment scene, you can still find yourself scratching and turning your head on where to put your money. In such a case, perhaps an ETF may be your best bet.
What is an ETF: A Baby Analogy
ETF stands for “Exchange-Traded Fund”. You can take this analogy to understand what an ETF is: You are friends with a couple who is expecting their first baby. There will be a baby shower, and you cannot go to a baby shower without gifts. You go online and check all the possible gifts you can give. You find that you can gift baby clothes, blankets, diapers, even a parenting journal. Great! All that is left is to narrow down your choices, but how can you decide? Diapers may be too generic. Others may be giving the same thing. Clothes are risky. What if they do not fit the baby? Now it seems you are with the confusion you with which you started. You continue your search, and lo and behold you find a store that offers baby gift packages! You can buy a whole basket that comes with baby clothes, a blanket, a towel, bath soap, and even a stuffed toy.
Buying a bunch of each baby item is both expensive and impractical. Instead, you can purchase the basket that contains a few or one of each. In this analogy, the baby items are securities, like stocks, while the baby basket is an ETF. Thus, an ETF is a group of assets that can come from various industries or in one sector. In this analogy, the ETF is from the “baby sector”. An ETF from the finance sector can carry assets from various banks, while an ETF from the healthcare sector can represent pharmaceutical companies.
Why go for an ETF?
By now, you may be thinking, “An ETF sounds like a mutual fund.” In a way, yes, since both carry various assets. Buying an ETF, therefore, allows you instant diversification. In more ways, no, since there are several subtle and stark differences. For starters, you can only trade a mutual fund once per day. In contrast, an ETF price fluctuates throughout the day, and you can trade it several times when the market is open.
Moreover, an ETF costs less than a mutual fund because of numerous reasons. One reason is a fund manager actively manages a mutual fund. In contrast, you can passively manage an ETF yourself, i.e., you can buy an ETF, let it sit, and check on it later hoping that its value went up. Thus, an ETF is perfect for someone who is just getting their feet wet in investing and also wants to diversify their portfolio.
Investing involves tricky waters, but the only way you learn to swim is when you dive in. As you learn the strokes, you can use ETFs as your floaters. Even when you become a shark in the waters, ETFs are still valuable assets that can strengthen your portfolio.
