An ETF can add flexibility to your portfolio
Investing in ETFs combines the flexibility of trading individual stocks with the built-in diversification and low costs of mutual funds.
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What's an ETF?
To define what an ETF is, let's break down the term.
ET = "exchange-traded"
An ETF is traded on a major stock exchange—like the New York Stock Exchange or Nasdaq.
If you've ever traded an individual stock, then buying and selling an ETF will feel familiar because it's traded the same way.
F = "fund"
Why an ETF instead of individual stocks & bonds?
Enjoy the convenience of an ETF, which already contains a preselected collection of stocks or bonds. If a single stock or bond in the collection is performing poorly, there's a good chance that another is performing well, which helps minimize your losses.
On the other hand, when you buy individual stocks and bonds, if one goes south, your savings could take a much bigger hit in a short period.
Leave the selection of stocks and bonds to a professional fund manager and save yourself the time and effort.
Just make sure you're familiar with the ETF's objective—what it's designed to achieve (such as income versus growth)—before you invest in it. You can certainly look at what specific stocks or bonds are in the ETF, but you don't have to keep track of every detail.
Buy and sell Vanguard ETFs in your Vanguard Brokerage Account and pay no commission—ever.
The alternative? Every time you buy and sell a stock or bond, you're likely paying a commission or trading fee. Although $5 or $7 doesn't sound like much for one trade, those costs can add up quickly over time when you're buying and selling an entire portfolio of individual stocks and bonds.
Why an ETF instead of a mutual fund?
Although ETFs and mutual funds share many similarities, there are a couple of distinguishing characteristics that may make ETFs more attractive to some investors, including:
- Lower investment minimums when you first start investing.
- Real-time pricing every time you buy and sell.
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Usually refers to a "common stock," which is an investment that represents part ownership in a corporation, like Apple, GE, or Facebook.
Each share of a stock is a proportional share in the corporation's assets and profits.
Represents a loan given by you—the bond's buyer—to a corporation or a local, state, or federal government—the bond's "issuer."
In exchange for your loan, the issuer agrees to pay you regular interest and eventually pay back the entire loan amount by a specific date.
An investment that attempts to track the performance of a specific index (sometimes referred to as a "benchmark")—like the popular S&P 500 Index, Nasdaq Composite Index, or Dow Jones Industrial Average. A mutual fund or an ETF buys all or a representative sample of the bonds or stocks in the index that the fund tracks.
A strategy intended to lower your chances of losing money on your investments.
Diversification can be achieved in many ways, including spreading your investments across:
- Multiple asset classes, by buying a combination of cash, bonds, and stocks.
- Multiple holdings, by buying many bonds and stocks (which you can do through a single ETF) instead of only one or a few.
- Multiple geographic regions, by buying a combination of U.S. and international investments.
A fund manager is hired by the ETF to watch over which stocks or bonds are included in the ETF.
A financial advisor is hired by you to manage your personal investments, which could include ETFs.
A fee that a broker or brokerage company charges every time you buy or sell a security, like an ETF or individual stock.
Maybe you're thinking about handcrafting your portfolio. Before you do, make sure you understand the costs. (All examples below are hypothetical.)
Trading individual stocks
Imagine you want 25 different stocks in your portfolio, each of which is selling for $50 a share, and you're charged a $5 commission for each trade.
$1,250 purchase price (25 stocks multiplied by $50 per share)
+ $125 in commissions (25 stocks multiplied by $5 per stock)
= $1,375 total cost
An ETF can help you obtain the same level of diversification but at a much lower cost.
For example, imagine you buy 1 ETF that holds all 25 stocks and costs $50 a share, and you enjoy Vanguard's commission-free trading.
$50 purchase price (1 ETF multiplied by $50 per share)
+ $0 in commissions (for Vanguard ETFs® held in a Vanguard Brokerage Account)
= $50 total cost
Just like an individual stock, the price of an ETF can change from minute to minute throughout any trading day. The price you pay or receive can therefore change based on exactly what time you place your order. This is sometimes referred to as "intraday" pricing.
On the other hand, a mutual fund is priced only at the end of the trading day. Regardless of what time you place your trade, you and everyone else who places a trade on the same day receives the same price, whether you're buying or selling shares.