Become a better investor
Lesson in Course: ETFs and mutual funds (beginner, 5min )
We're ready to start investing with ETFs. How do we decide which ones?
We can start out by looking at the broad U.S. stock market and then choose more focused investments. ETFs are the most cost-effective way to invest in hundreds of top companies in the U.S. stock market.
An S&P 500 ETF tracks the S&P 500 index, allowing us to invest in 500 large companies like Apple, Microsoft, Amazon, Facebook, Google, Tesla, Berkshire Hathaway, JP Morgan, and Johnson & Johnson in one investment.
SPY and SPLG are the most popular S&P 500 ETFs. Both ETFs are issued and managed by State Street Global Advisors, an institutional asset management firm that invented the world's first ETF.
The SPDR S&P 500 Trust ETF is the first ETF ever created and trades under the ticker symbol SPY.
SPY has the most liquidity with over $350B under Management, meaning there are many buyers and sellers for SPY. It's effortless to find someone willing to buy or sell shares. Since SPY trades at several hundred dollars per share, it has an expensive entry point to buy one share. SPY was trading at over $400 per share in June 2021.
State Street created SPDR Portfolio S&P 500 ETF with the ticker SPLG to provide investors a lower-priced entry point.
We can expect SPLG and SPY to have similar returns since they both track the same index. However, one share of SPLG is much more affordable at about 1/10th the price per share of SPY. The lower cost per share means buying smaller amounts of the same shares that make up SPY. SPLG was trading at over $40 per share in June 2021.
When starting a portfolio, it's risky to invest all of our money at once. Doing so exposes us to market-timing risk; the chance of investing right before a market crash. We can reduce this risk by using dollar-cost-averaging to make our investments in smaller, more frequent bites.
For example, if we have $2,000 to invest this year, we could split it into four investments of $500 every 3 months or $167 every month.
The advantage of more frequent investments (e.g., monthly) is that it allows us to respond to changes in the market faster. In this case, with SPY at over $400 per share, it would be too expensive to buy a share every month, so we would have to invest quarterly. Instead, SPLG offers us more flexibility because $167 a month could buy a few shares of SPLG.
The advantage becomes less relevant if our brokerage allows us to buy fractional shares, the ability to buy a piece rather than a whole share.
The S&P 500 only includes 500 of the biggest companies listed on the stock exchanges. It doesn't contain the many mid to small-sized companies that often grow faster than large companies. Instead of an S&P 500 ETF, a total market ETF would include smaller companies.
VTI is the ticker of the Total Stock Market ETF created by Vanguard, another famous asset management firm, to give investors access to smaller stocks in addition to companies in the S&P 500.
Comparing the annual returns of VTI to the S&P 500, VTI has better returns than the S&P 500 in some years but not others.
However, if we look at averaged returns over 5 years, VTI has performed slightly better. In times of economic growth and expansion, smaller companies tend to provide higher returns than larger companies, but larger companies perform better during economic contraction and recession.
Besides broad stock market ETFs, we can invest in specialized ETFs or ones that represent other asset classes. We can use them to increase or decrease our portfolio's risk like the examples below.
QQQ is an ETF created by Invesco to track the top tech companies, more specifically the Nasdaq-100 index.
Tech stocks tend to be riskier but can have higher returns than the total market or S&P 500. At times, the 5-year return of QQQ has seen nearly double the S&P 500's return.
Tech stocks are susceptible to economic downturns and rising interest rates. There's no guarantee of future returns, so high returns can significantly decrease in the future. QQQ is often used to take more risk for potentially higher returns.
We can also invest in other types of assets through ETFs. AGG is the ticker symbol for the CORE US Aggregate Bond ETF created by iShares. This ETF makes it easy for us to invest in bonds by following the total U.S. investment-grade bond market.
When a bond ETF is added to a portfolio with stocks, it helps lower our portfolio's risk by diversifying with a different type of asset.
We can check out the lesson getting to know bonds for a quick refresher about what they are.
In general, bonds earn much lower returns than stocks; however, bonds tend to perform better during recessions. A bond ETF like AGG helps lower the portfolio's risk by diversifying across multiple asset classes when added to a portfolio invested in stocks.
Here’s a helpful list of top ETFs ranked by popularity and money invested:
The number of investment options available can seem overwhelming. A good strategy is to start with a broad investment like a Total Market or S&P 500 ETF. Over time, we can add more ETFs of other asset classes like bonds or more targeted ETFs like tech. Which ones we add will depend on if we want to add or reduce risk.
Some modern brokerages like Robinhood, TD Ameritrade, Stash, and Public offer fractional shares that allow us to buy more expensive products like SPY without purchasing a full share. If we can buy fractional shares, there isn't a significant difference between ETFs like SPY and SPLG.
State Street SPDR S&P500 ETF.