Exchange-traded funds (ETFs) have many features that can make these investments exemplary for young investors with small amounts of capital to invest. They're also great for those who may not yet have much investment knowledge.
ETFs allow a younger investor to build a diversified portfolio, and it doesn't take much money to begin. ETFs trade throughout the day, providing ample liquidity, and many have relatively low fees. Most ETFs track specific indexes; the largest ETF worldwide by assets under management is SPDR S&P 500 ETF Trust (SPY).
"With this approach, an investor can keep fees low while diversifying their portfolio across industries, sectors, and geographies," said David Tenerelli, a certified financial planner at Strategic Financial Planning in Plano, Texas. "This can result in the investor approximating 'universal ownership'—owning a representative slice of the entire global economy —and positioning yourself to benefit from broad economic growth, regardless of the fortunes of individual companies." But this, too, can have risks, like all investments, he noted, should the market the ETF tracks go down.
There are at least five reasons young investors might want to consider ETFs for potential investment opportunities.
Key Takeaways
- Exchange-traded funds (ETFs) offer investment prospects for young people with relatively small amounts of capital and a rudimentary knowledge of how investing works.
- There are over 3,500 U.S.-based ETFs to choose from, allowing investors to participate in a wide variety of different markets.
- ETFs can be bought and sold throughout the trading day and many are highly liquid with substantial trading.
- Most ETFs use a low-cost indexing approach.
1. Variety
The first ETFs were introduced in the U.S. in 1993. These relatively simple products tracked equity indexes such astheS&P 500 and the Dow Jones Industrial Average. This means it takes an index like the Dow Jones and replicates it in the fund by the number and size of the companies in that index. As such, when the S&P 500 goes up, the ETF based on it should go up proportionately.
Since then, ETFs have expanded to include practically every asset class: stocks, bonds, real estate, commodities, currencies, and international investments, as well as every sector and niche area imaginable. The chart below gives a sense of the variety through the market share by the number of ETFs for each type.
The ETF market is highly competitive. This means there are very focused ETFs that young investors can choose from and that track particular markets or segments that may appeal to them. As of mid-2024, there were almost 3,600 U.S.-based ETFs available for investors to trade. This extensive range of available ETFs offers a wide variety of investment choices for young investors.
Because there are so many options, an investor can build a diversified portfolio with less capital. Consider the case of a young investor with $2,500 to invest. Let's assume that this investor is knowledgeable about financial markets and has views on specific investments. They are optimistic about U.S. equities and want U.S. stocks to be their core investment position. They also want to invest in smaller positions with their bullish views on gold and the Japanese yen, expecting both to move higher.
While this portfolio would have required more capital in the past (especially before the advent of commodity and currency ETFs), the investor can build a portfolio incorporating all views using ETFs with the $2,500. They may invest $1,500 into the SPDR S&P 500 ETF Trust (SPY) and $500 each in theSPDR Gold Fund (GLD) and the Invesco CurrencyShares Japanese Yen Trust (FXY).
:max_bytes(150000):strip_icc()/BRIEFHISTORYETFs-67d5709a0fa04b7bb170dd2a494a6cb8.png "Why ETF Investing Is Ideal for Young Investors (1)")
2. Liquidity
ETFs are just like stocks. This means you can buy and sell shares of an ETF the same way you would for any U.S. stock, such as a blue chip or small-cap company. This means these investments are highly liquid (you can quickly cash them out and buy and sell them) and can be traded throughout the day.
Because of their liquidity, ETF investors have an advantage over index mutual funds, which are priced only at the end of the business day. This could make a critical difference for the young investor, who might want to exit a losing investment immediately to preserve a limited amount of capital.
Ample liquidity also means investors can use ETF shares for intraday trading, like stocks.
Many ETFs adhering toenvironmental, social, and governance (ESG) investing principles have been launched as well.
3. Low Fees
Investments cost money. The fees associated with these investments are for investment firms, portfolio or fund managers, and advisers. Some ETFs charge their clients exorbitant fees, while others incur modest costs. ETF fees include expense ratios, management fees, or commissions.
"One of the most significant headwinds to profitable investing is management fees," Tenerelli said. ETFs generally have lowerexpense ratiosthan mutual funds, though fees have fallen significantly for both in the last two decades and are far closer in cost than previously.
Like stocks,manyonline brokersnow offer commission-free ETFs, even for investors with small accounts. This can significantly help young investors, as high fees and commissions could put a dent in their account balance.
4. Flexibility to Choose a Management Style
ETFs allow investors to manage their investments in the style they choose, whether passive or active. Passive management, or index investing, is by far the most popular. It can also often be more profitable than the ETFs of actively managed peers.
Index investing involves fund managers building a portfolio to mimic one or more market indexes. Meanwhile, active management entails a more hands-on approach, with managers selecting specific stocks or sectors in an attempt to beat the market.
Young investors unfamiliar with the financial markets' intricacies would be well-served by using a passive management approach initially. Only once they've gained knowledge and experience and have the right risk tolerance should they gradually move to a more active style as their investing knowledge increases, Tenerelli said.
Sector ETFs allow you to take bullish (optimistic) or bearish (pessimistic) positions in specific sectors or markets. Inverse ETFs trade in the opposite direction of an asset or market—when that market is up, it goes down and vice versa—while leveraged ETFs magnify results by two or three times, doubling or tripling your profits or losses, as the case may be. Both of these are sophisticatedportfolio managementstrategies.
5. Keeps Up With Trends
A principal reason for the rapid growth of ETFs is that their issuers have been at the leading edge of introducing new types of products.
ETF issuers typically respond rapidly to the demand for products in hot sectors. For example, many commodity ETFs were introduced during the commodity boom between 2003 and 2007. Some of these ETFs track broad sets of commodities, while others track specific commodities such as crude oil and gold.
Fund managers' work to bring out new ETFs to fit changing markets will likely appeal to many young investors, who have more to make up for investments gone wrong. Among the new ETFs introduced to meet demand are crypto futures and the spot crypto ETFs in the early 2020s.
In January 2024, the U.S. Securities and Exchange Commission (SEC)approved trading for spot bitcoin ETFs, with the go-ahead for spot ether ETFs coming later in the year. These approvals "mark a monumental shift in the regulatory landscape," Christina Lynn, a behavioral finance researcher and certified financial planner at Mariner Wealth Advisors, told Investopedia. "These approvals lend legitimacy to the asset class and provide [investors] with a more straightforward, regulated investment vehicle."
This landmark decisionnot onlylegitimizes bitcoin as an investable assetbut alsoprovides institutional and retail investors with a more regulated and accessible way to invest in cryptocurrencies.This decision by the SECis expectedto bring an additional level of liquidity, transparency, and investor protection to the cryptomarketwhile potentially setting a precedent for other digital assets in the ETF space.
When Was the First ETF Launched?
The world's very first ETF was launched in Canada in 1990. It was established by the Toronto Stock Exchange (TSX) and was called the Toronto35 Index Participation Units. State Street Global Investors issued the first ETF—the S&P 500 Trust ETF—in the U.S. three years later. It's also the most heavily traded and largest ETF in the world at over $500 billion.
How Much Does It Cost to Invest in an ETF?
ETFs are relatively low-cost investments, especially when you compare them to other vehicles like mutual funds. The major cost of owning an ETF comes from the expense ratio, which is charged to investors to hold the investment. Other fees include commissions, broker fees, and bid-ask spreads.
How Does ETF Investing Work?
Exchange-traded funds are similar to mutual funds and stocks. They resemble mutual funds because they pool money together from multiple investors that are then invested in a basket of related securities. Some ETFs may focus on U.S. equities while others may be invested in fixed income. Some funds are concentrated on niche investing like technology securities and clean energy-related companies. ETFs trade like stocks on exchanges, which means you can buy and sell shares at any time.
The Bottom Line
ETFs are a great way for people to test the investment waters. Young investors unfamiliar with the financial markets' intricacies might be well-served by investing in anETF that tracks the broader market.
Sector funds allow investors to take bullish or bearish positions in specific sectors, while inverse ETFs and leveraged ETFs make it possible to incorporate sophisticated portfolio management strategies.Some other characteristicsof ETFsthat make them suitable investments for young investors include diversification,liquidity, low fees,and the ability to choose among different types of managers and strategies.
