Word has gotten out that you don’t have to be a day-trading guru or have a finance degree to make money in the stock market. In fact, you don’t even need to monitor your investments all that often to see healthy returns.
Creating a passive investing plan and sticking to it is one of the best ways for newbie investors to get started. Choosing a balanced selection of quality investments will likely result in better gains than frenzied buying and selling based on the latest stock predictions.
In this article, we’ll discuss an easy, set-it-and-forget-it investing strategy for beginners using exchange-traded funds, or ETFs. These investments are already diversified and cover almost any asset class you can imagine.
ETFs offer some great advantages to newbie investors, and you don’t have to set foot in a brokerage office to access them. Use a trading app like M1 Finance, and you can invest in ETFs on your phone in your pajamas.
What’s an ETF?
A key principle in investing is to spread out (or diversify) your risk by owning many stocks, not just a few. One simple way to do this is to invest in exchange-traded funds or ETFs.
An ETF is a group of securities (like stocks or bonds) that trades together like a single one. Just like an individual stock, each ETF has its own ticker symbol, and its price fluctuates from minute to minute on the stock exchange.
ETFs help investors diversify their risk by owning a variety of assets in a single bucket. For instance, if you own a stock ETF, you own a small piece of every stock that the ETF holds.
Think of it as a cake with multiple layers. One slice of that cake will get you a small piece of every layer, so you don’t have to eat multiple cakes to enjoy all the flavors.
And like cakes, ETFs come in a zillion varieties and sizes. ETFs can hold stocks, bonds, real estate, and other types of assets.
There are ETFs that hold only technology stocks or only foreign stocks or only commercial real estate. Because there are so many potential combinations, there are actually more ETFs than there are stocks!
What’s a Passive ETF?
Many funds are actively managed by financial professionals who pick and choose which stocks to include. They aim to select only the best-performing assets for their funds. Funds often focus on a specific sector like U.S. retail or energy.
Actively managed funds charge fees to their customers, which go to paying the fund manager and eat into the fund’s earnings.
Unlike their actively managed counterparts, passive ETFs don’t require a manager to pick, choose, and balance their assets.
They mirror an index, like the Dow Jones or the S&P 500, so the list of equities is preselected. So if you own an ETF like SPDR, VOO, or IVV, you’ll own a piece of every stock in the S&P 500.
Passive ETFs are designed for buy-and-hold investing. They include a wide variety of stocks and are more diverse than many active ETFs. Those who buy and hold passive ETFs operate under the assumption that it is better to match the gains of the market than trying to choose only winning stocks or funds.
Is Hands-off Investing Right for Me?
If you’re a beginner investor, all the charts, lingo, and choices can be confusing and intimidating. Isn’t there a way to just own a little bit of everything?
That’s exactly what you do by using a hands-off ETF investing plan—hold a wide variety of assets in multiple areas and industries, so if one stock or sector tanks (like the housing market in 2008 or the dot-com bust of the late 1990s), your whole portfolio is cushioned from the blow.
Passively investing in ETFs is a great strategy if you:
- Don’t want to spend a lot of time picking stocks
- Want to hold your assets for a long time
- Want to keep your strategy simple
Why Use a Hands-off Investing Strategy?
In addition to its simplicity, passive investing comes with numerous perks. When you set and forget your ETFs, you also enjoy:
- Better odds. This is probably the most compelling reason to adopt a passive investing strategy. Less than a third of actively-managed funds beat their corresponding benchmarks, and that number is falling. You actually have a better chance of making more money by trying to match the market than if you try to beat it!
- Low fees. The high fees of actively managed funds will eat into your returns. Because passive ETFs track an index, there’s no need to pay a manager, so you as the consumer pay lower fees to hold them—which translates to more money for you.
- Less worry. If you don’t know much about stocks or investing, using passive ETFs to cover a few major indexes will get you started on the right foot.
- Fewer transaction costs. If you buy and hold your passive ETFs, you’ll save on transaction costs as you’re not buying or selling very often. This means more money stays in your account. Sign up with apps like Robinhood or M1 Finance for commission-free trades.
- Fewer emotionally based decisions. Take advantage of dollar-cost averaging (smoothing out high and low stock prices by buying consistently), and avoid regrettable, emotional decision-making by making a passive plan and sticking to it.
Plus, some of Wall Street’s biggest names recommend using passive investing to build their wealth.
Thanks to big-name proponents like Jack Bogle and Warren Buffet, passive investing has gained a lot of traction in the past few decades. As of 2019, more U.S. equity assets are managed passively than actively.
Developing a Set-It-And-Forget-It Investing Strategy
In a hands-off investing strategy, you come up with a plan and stick to it. Developing a plan involves some research. Before you buy ETF shares, you’ll want to decide what asset classes or indexes you want your investments to cover. Here are a few examples:
- Large-cap US stocks
- Mid-cap US stocks
- Small-cap US stocks
- Foreign stocks
- Real Estate
- Emerging markets stocks
- High-dividend stocks
- Growth stocks
- Value stocks
This list is far from comprehensive but covers most of the large asset classes available in ETF form. Let’s check out some other things to investigate for your passive ETF plan.
When inspecting ETFs, be sure to look at the expense ratio (the fees associated with holding the fund). With a passive fund, they’ll likely be less than 0.2 percent. The lower the expense ratio, the more of your money you get to keep.
Even though any ETF you choose will hold multiple assets, some are riskier than others. Choose ETFs that match your risk tolerance. As a rule, the closer you are to retirement, the less risky your investments should be. A quick lookup on Morningstar will tell you a fund’s risk level.
This is the return rate the fund has produced in the past. While it’s no guarantee of future performance, it can be a good indicator of whether the fund is worthwhile.
Once you’ve decided on your preferred mix of ETFs, the hard part is over. Now, just consistently contribute to your investments each month, sit back, and watch them grow.
If one of your ETFs does particularly well, you may need to rebalance your portfolio once a year so you aren’t too heavy on any given fund.
A Word on Diversity
Just because you have an ETF with multiple stocks in it doesn’t make your portfolio diversified. Use different ETFs to achieve diversity across company size, company location, and asset class.
Also, check whether you’re doubled up on any investments. If you have a few individual stocks in your account, see whether those make up a major piece of any of your ETFs. (You can check the holdings of any publicly traded ETF here.)
If you own multiple ETFs, make sure they don’t all hold the same assets, or that will defeat the purpose of using ETFs to diversify your risk.
Stock Trading Apps for ETF Investments
In days of yore, you’d saddle your mule and ride to the brokerage house and ask an actual human (*gasp*) to help you buy an ETF, then pay him/her for the trouble.
Thankfully, no mules or brokerage houses are necessary for passive ETF investors these days, as most transactions are done online or through apps.
The new industry standard price for most trades is $0, so when choosing an app, be sure to look for commission-free trades. Most apps also have some pre-set portfolio recommendations if you’re unsure of what’s best for you.
Many stock trading apps support ETFs, but our personal favorite is M1 Finance. This app supports brokerage and IRA accounts, so you have options on how long you want to hold your assets.
Its pie-based interface is specifically designed with passive investing in mind. This allows you to set your ideal allocation of ETFs and forget about it, as the app automatically rebalances your assets for you.
M1 Finance also allows for fractional shares, which is great if you don’t have a ton of cash to start investing. If you want to buy a share of SPDR, but you only have $50 and it’s trading at $350, no problem—you’ll just own 1/7th of a share of SPDR.
Other popular apps like Robinhood, Webull, and Acorns also support ETFs.
What’s the Difference Between an ETF and a Mutual Fund?
On the surface, EFTs and mutual funds are a lot alike. They both have a variety of assets held inside them, and many ETFs and mutual funds track indexes.
One main difference is that ETFs trade like a stock: they go up and down every minute of every trading hour. The price of a mutual fund is like a box of cereal—it posts at the end of the day and you buy it at that price until it changes.
Also, mutual funds often come with steep minimums (which can range from $500 to $5000). Prices on ETFs are usually more affordable and can be purchased in whole or fractional shares on apps like M1 Finance, making them more accessible for beginning investors.
After reading The Simple Path to Wealth, I wanted to invest part of my portfolio in VTSAX, Vanguard’s total stock market index mutual fund. But the minimum investment was a whopping $3,000!
I didn’t have that much cash lying around at the time, and I didn’t want to sell the investments I already had, so I opted for VTI instead. The stocks held by VTI are nearly identical to those held in VTSAX, but VTI is an ETF.
So instead of saving up to invest a few thousand dollars, I could buy a couple of shares for a few hundred dollars and get exposure to the same stocks much sooner.
Can I Invest in ETFs in my Retirement Account?
Definitely! If you’re looking to buy and hold the ETFs until retirement, then you should buy them inside a retirement account (401k, Roth IRA, Traditional IRA, etc.) to minimize your taxes.
Most of my retirement account is in passive ETFs, actually. Some of my personal favorite passive ETFs are VOO, which tracks the S&P 500; VTWO, which focuses on small U.S. businesses; and VTI, which gives me a little bit of everything.
These don’t cover every inch of the market, but they do cover the basics and give me a good amount of diversity.
Before selecting your own ETFs, do your research and make sure your portfolio is balanced with your risk tolerance and time horizon.
What if My Retirement Account Doesn’t Offer Passive ETFs?
Not every retirement plan will offer every ETF, so check with your employer or your existing plan provider to see what’s available.
My husband and I ran into this very situation when his employer changed retirement plan providers this year. The new provider offered only target-date funds, which didn’t offer the control we wanted over our investments.
If you don’t like the options in your current account, you can open an additional account with a brokerage like Fidelity or Vanguard—which is exactly what we did.
We contribute enough in my husband’s employer-sponsored account to get the company match, and we invest the remainder of our retirement money in our personal Vanguard accounts so we can pick and choose the stocks and ETFs that are right for us.
For beginning investors who want to set it and forget it, a portfolio that includes passive ETFs is a step toward building a diverse portfolio that consistently grows your money over time.
With passive ETFs, you’re not looking to pick hot penny stocks or get blockbuster returns. Instead, you bet on a variety of assets and skip expensive management fees.
If you’re invested for the long haul, you can expect to do as well as the market indexes that your passive ETFs track and better than most actively managed funds.
Contributor’s opinions are their own. Always do your own due diligence before investing.