Start investing with ETFs
February 24, 2017
One of the greatest advantages young investors have is time. The more time you have, the more the power of compounding can work for you.
But if you're like many other millennials who are just starting out, building a well-diversified investment portfolio may seem out of reach. ETFs could be a good way to kick-start your savings and investment plan.
"Millennials are the fastest-growing segment of ETF investors. With such strong adoption among this demographic, ETFs are igniting a new generation of investing," said Richard Powers, head of ETF Product Management at Vanguard.
Here's why ETFs are starting to dominate millennials' portfolios:
- ETFs offer a low-cost way to invest. Funds that track an index, whether ETFs or mutual funds, typically cost less and are more tax-efficient than actively managed mutual funds. The savings that come from investing in a low-cost fund can add up and compound into greater wealth over time. Combine that with the advantage of investing early, and the potential for a difference in wealth can be considerable.
One consideration, though, are transaction costs. If you're charged a $7 commission to make a trade, purchasing an ETF share that costs $100 means your investment will need to rise by a little more than 7.5% before you see any gains. If you have a Vanguard Brokerage Account, there is no cost to trade Vanguard ETFs. So, that $7 commission is completely avoidable.*
- ETFs have a low hurdle to invest. The minimum to purchase an ETF is one share, potentially as little as $100. Contrast this to mutual funds, which might require an initial investment of as much as $3,000. (Some mutual funds can be opened with as little as $1,000.) ETFs can make it easier for a newbie investor to get started, and continue building wealth in manageable increments.*
Also, it doesn't take much to construct a balanced portfolio. You can put $100 in a stock ETF and $100 in a bond ETF to achieve a diversified two-asset-class portfolio which, though simple, can be a great start toward building a portfolio appropriate for your goals. ETFs can be a simple way to build incrementally toward your long-term plan.
- ETFs can offer instant diversification. Most ETFs are designed to match the performance of the index they track. As long as the ETF strategy is broadly invested across the market, such as our first ETF, Vanguard Total Stock Market ETF (VTI), which is diversified across 3,600 stocks, one single share can provide you with all the diversification you need within the U.S. market.
But not all ETFs provide the same level of diversification; some ETFs offer concentrated exposure in specific market sectors, such as one of our largest sector ETFs, Vanguard Health Care ETF (VHT), which invests in health care stocks.
The earlier you start, the less you have to save
This hypothetical example shows just how powerful compounding can be for the early investor. Two people with similar financial goals start investing at different times:
- Dawn starts investing at age 25 and contributes $2,000 each year for 10 years (until she's 35 and has invested $20,000).
- Dave starts investing at age 35 and contributes $2,000 each year for 30 years (until he's 65 and has invested $60,000).
Assuming that their investments earn 8% a year, at age 65, Dawn will have $314,870. Dave will have $244,692. So even though Dave saved more and for a longer period of time, Dawn will have over $70,000 more in her retirement account than Dave. (Sorry, Dave.)
Hypothetical rates of return illustrated in this article are not guaranteed.
So how do you start investing in ETFs?
You'll need a brokerage account to trade ETFs. Whether you're investing from your retirement or taxable account, if you can buy or sell stocks in it, then you can also buy an ETF.
The longer you keep your money invested, the better your odds are of overcoming periods of market decline. This is just one factor among many that lead to long-term investing success. For more information on Vanguard's principles for investing success, click here.
*Trading limits, fund expenses, and minimum investments may apply.
- All investing is subject to risk, including the possible loss of the money you invest.
- Diversification does not ensure a profit or protect against a loss.
- Vanguard ETF Shares are not redeemable with the issuing fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.
- Funds that concentrate on a relatively narrow sector face the risk of higher share-price volatility.