Invest Smart and Beware of Fees

"How can I invest in anything you guys recommend without already having a lot of money to do it?"

That's the question I (Laura Bente) got from a young investor recently. A longtime reader, let's call him James, finally has job security and a solid plan to pay off his debt. James wants to start investing, but as he told me, he doesn't have several thousand dollars ready to put into the market.

It's a problem I see often with people who want to invest but assume they lack the money, time, or know-how to do it.

Now, let's say you want to invest in the stock market... but following individual companies seems overwhelming.

Or maybe you know that owning a collection of 20 or 30 stocks is safer than owning just one or two stocks, but you only have a few hundred bucks to invest.

That's when exchange-traded funds (ETFs) can come in handy.

ETFs have gotten a lot of attention lately. One reason is the rise in popularity of a newer type of ETF that focuses on environmental, social, and governance issues – called ESG funds.

So today, I want to get back to basics and explain how ETFs work, what they can add to your portfolio, and one of the biggest red flags to watch out for...

The concept behind ETFs is simple: A large group of investors pool their money by buying shares. Then, a professional money manager invests that pool of money into a variety of stocks and bonds. He collects a fee for his services. And the investors get a diversified basket of investments through one single purchase.

Instant diversification is one of the greatest benefits of ETFs. For instance, as an investor, you may want to own bonds. But taking the time to research the right bond to buy, and then buying it, can be difficult and expensive. There are a number of bond ETFs that track various bond indexes or specialize in a certain type of bond.

You can also buy "sector focused" ETFs. These let you zero in on a part of the stock market that you believe is moving in one direction or the other. For example, if you think the technology sector is about to rise dramatically, you can buy an ETF that tracks technology or parts of the sector.

Some of the sector funds include:

  • Global ETFs
  • Real estate ETFs
  • Precious metals ETFs
  • Derivative ETFs 

The most popular ETFs are index-based ETFs, which track the overall movement of indexes like the S&P 500.

And buying an ETF is just like buying a normal stock. There are no special steps to take – just give your broker the fund's ticker symbol instead of an individual stock's.

But beware of the fees.

ETFs have an expense ratio that calculates the annual fees the fund charges as a percentage of its assets. The higher the expense ratio, the more you're paying in fees.

And those fees add up over time. Let's say you're investing $5,000 annually in a fund over a 40-year period. Each year, the fund's value goes up by 8%. Here's how your account would look after 40 years with a range of fees...

How Fees Eat Away Your Wealth
Fee Account Value After 40 Years
0.05% $1,378,000
0.39% $1,247,000
1% $1,045,000
2% $786,000

If you're only paying a 0.05% fee, your account would be worth nearly double what it would be if you pay 2%.

So before you buy a fund, look at its expense ratio. You can easily find this information with a quick search on Yahoo Finance, Morningstar, or through your brokerage account. And lots of companies offer their own ETFs like iShares, Global X, Invesco, SPDR, PIMCO, and Vanguard – all of which run ETFs you can buy on the New York Stock Exchange.

And they each offer a range of ETFs to fulfill different financial needs, investing styles, and risk levels.

When you're just starting out, finding the right ETF for you can seem overwhelming. That's why I recommend beginning your search with Morningstar's ETF screener. (You need to create a Morningstar account to use it, but it's free.)

The screener lets you search for ETFs based on a long list of criteria, including what the fund invests in, risk, historical performance, and fees.

I love ETFs for people just starting out. The low cost and instant diversification make ETFs an easy choice when you don't have a lot of money or time to invest. You sacrifice the potential for big gains you'd get through buying individual stocks – one single stock is more likely to explode than an entire fund – but if you can't afford to take big risks, ETFs are a solid place to put your cash to work.

Just make sure you don't give away all your gains to the fund manager.

If you want to know the best ways to grow – and protect – your wealth this year, don't miss tonight's urgent briefing. Doc Eifrig, Dr. Steve Sjuggerud, and Matt Weinschenk will discuss what's going on in the markets now and what to expect in the future. Plus they'll each give away their No. 1 investment for 2022.

Click here for more details and to reserve your spot.

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Here's to our health, wealth, and a great retirement,

Laura Bente, CFP® with Dr. David Eifrig
January 27, 2022