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ETFs or Exchange-Traded Funds are a great way to start investing in the stock market that will give you immediate diversification to the market. This post will give you all the knowledge you need to start investing in ETFs as we will answer the most frequent asked questions about ETFs with detailed examples of how you can grow your wealth and be financially independent.
What are Exchange Traded Funds?
ETF or Exchange Traded Fund is a type of investment fund that track a basket of companies. ETF tracks the top-performing companies in a specific market passively. ETFs are flexible, low cost and low maintenance and can be purchased and traded just like individual stocks. The S&P 500 is the most common and widely known ETF that tracks the top 500 performing companies in the US.
Top 5 Well-Known High Return ETFs?
| Name | Ticker Symbol | Tracks | Historic Annual Return |
|---|---|---|---|
| Vanguard S&P 500 ETF | VOO | Tracks the top 500 companies in the US | 9.5% (25- year average) |
| SPDR Dow Jones Industrial Average ETF Trust | DIA | Tracks the top 30 companies in the US | 7.3% (25- year average) |
| Vanguard Information Technology ETF | VGT | Gives exposure to the technology sector | 12.5% (15-year average) |
| iShares Russell 2000 ETF | IWM | Tracks 2000 small us companies | 9.6% (25- year average) |
| Invesco NASDAQ 100 ETF | QQQM | Tracks the NASDAQ stock exchange’s top 100 companies | 12.9% (10-year average) |
Are ETFs a good way to invest?
Investing in market-tracking ETFs is the easiest way to invest your money. When you buy an ETF, you immediately diversify your investment portfolio by purchasing a small slice of all the companies tracked by that index; this gives you great exposure to the stock market without the need to buy individual stocks.
ETFs have low-cost management fees. The S&P 500 is the most common and widely known ETF that is tracked by both Vanguard and iShare with low annual management fees, as shown below:
| S&P 500 ETF | Annual Management Fees |
|---|---|
| Vanguard S&P 500 ETF (VOO) | 0.03% |
| iShares S&P 500 ETF (IVV) | 0.04% |
In addition, investing in an ETF can make a significant return in the long term. If you invest $5,000 a year for the next 20 years in an ETF that averages around 9% annual return, in 20 years, you would have invested $100,000 but made $178,822.65 in total compound interest earned on your investment. That means that in 20 years, you have increased your wealth by almost 1.8 times.
| Year | Deposit | Current Balance | Interest | Total |
|---|---|---|---|---|
| 1 | 5,000 | 5,000 | 450 | 5,450.00 |
| 2 | 5,000 | 5,450.00 | 940.50 | 11,390.50 |
| 3 | 5,000 | 11,390.50 | 1,475.15 | 17,865.65 |
| 4 | 5,000 | 17,865.65 | 2,057.91 | 24,923.55 |
| 5 | 5,000 | 24,923.55 | 2,693.12 | 32,616.67 |
| 6 | 5,000 | 32,616.67 | 3,385.50 | 41,002.17 |
| 7 | 5,000 | 41,002.17 | 4,140.20 | 50,142.37 |
| 8 | 5,000 | 50,142.37 | 4,962.81 | 60,105.18 |
| 9 | 5,000 | 60,105.18 | 5,859.47 | 70,964.65 |
| 10 | 5,000 | 70,964.65 | 6,836.82 | 82,801.47 |
| 11 | 5,000 | 82,801.47 | 7,902.13 | 95,703.60 |
| 12 | 5,000 | 95,703.60 | 9,063.32 | 109,766.92 |
| 13 | 5,000 | 109,766.92 | 10,329.02 | 125,095.95 |
| 14 | 5,000 | 125,095.95 | 11,708.64 | 141,804.58 |
| 15 | 5,000 | 141,804.58 | 13,212.41 | 160,016.99 |
| 16 | 5,000 | 160,016.99 | 14,851.53 | 179,868.52 |
| 17 | 5,000 | 179,868.52 | 16,638.17 | 201,506.69 |
| 18 | 5,000 | 201,506.69 | 18,585.60 | 225,092.29 |
| 19 | 5,000 | 225,092.29 | 20,708.31 | 250,800.60 |
| 20 | 5,000 | 250,800.60 | 23,022.05 | 278,822.65 |
| Sum | $100,000 |
How to Invest in ETFs?
There are a few strategies to invest in ETFs. Implementing a Dollar Cost Averaging strategy or DCA is the most effective investment method. The DCA strategy is investing a specific amount of money at regular periods, such as every 3 months. Instead of depositing a huge amount of money once a year, you deposit that amount in small deposits throughout the year.
This strategy can give the market average, which makes your investing completely passive. This means you do not have to worry about the market being overpriced or underpriced when you invest because breaking up your annual lump sum into small investments throughout the year will give you the average of the market in the long term.
If you have never invested in the stock market before, you can check our guide that will show you exactly how to do it through 5 Actionable Steps To Start Investing In The Stock Market.
How investing in ETFs is risk-free?
Throughout history, the stock market has often become overvalued; this overvalued period usually happens when people become irrational and invest in risky assets that result in a crash where the stock market fall, also known as a bubble.
Following the crash is a down period where the market is undervalued, and after a while, the market returns to normal. This cycle always happens and is almost impossible to avoid.
If you look at the last few recessions, the “.com” bubble in 2000 and the housing market crash in 2008, people thought it was a bubble at that time which it was. You would have seen a crash if you invested during any or all of those bubbles. However, if you look at the stock market now, it has grown way more since the last stock crash.
Therefore, if we are in a bubble now, it does not make any difference for the long-term investor because the market seems to always give its fair value in the long term. Therefore, investing in ETFs can be risk-free if the investor is always long-term set.
Why should you invest early in ETFs?
Investing early in your life gives you the benefit of time. If you let your money compounds itself for 30 years, the returns are much higher than only investing for 20 years. In addition, if you invest heavily at the beginning, your money can grow exponentially.
The following examples show why investing early in your life can give you high returns.
Example 1: Investing $150,000 for 20 years
Let us take a hypothetical example of consistently investing for 20 years in an ETF that gives you a 10% annual return on your investment. For the first 10 years, you only invest $5000, and after the first ten years, you invest $10,000 until the end of the 20 years. In 20 years, you would have invested $150,000 and made a total of $402,668.33, which is a growth of wealth by 2.7.
| Year | Deposit | Current Balance | Interest | Total |
|---|---|---|---|---|
| 1 | 5,000 | 5,000 | 500.00 | 5,500.00 |
| 2 | 5,000 | 5,500.00 | 1,050.00 | 11,550.00 |
| 3 | 5,000 | 11,550.00 | 1,655.00 | 18,205.00 |
| 4 | 5,000 | 18,205.00 | 2,320.50 | 25,525.50 |
| 5 | 5,000 | 25,525.50 | 3,052.55 | 33,578.05 |
| 6 | 5,000 | 33,578.05 | 3,857.81 | 42,435.86 |
| 7 | 5,000 | 42,435.86 | 4,743.59 | 52,179.44 |
| 8 | 5,000 | 52,179.44 | 5,717.94 | 62,897.38 |
| 9 | 5,000 | 62,897.38 | 6,789.74 | 74,687.12 |
| 10 | 5,000 | 74,687.12 | 7,968.71 | 87,655.84 |
| 11 | 10,000 | 87,655.84 | 9,765.58 | 107,421.42 |
| 12 | 10,000 | 107,421.42 | 11,742.14 | 129,163.56 |
| 13 | 10,000 | 129,163.56 | 13,916.36 | 153,079.92 |
| 14 | 10,000 | 153,079.92 | 16,307.99 | 179,387.91 |
| 15 | 10,000 | 179,387.91 | 18,938.79 | 208,326.70 |
| 16 | 10,000 | 208,326.70 | 21,832.67 | 240,159.37 |
| 17 | 10,000 | 240,159.37 | 25,015.94 | 275,175.31 |
| 18 | 10,000 | 275,175.31 | 28,517.53 | 313,692.84 |
| 19 | 10,000 | 313,692.84 | 32,369.28 | 356,062.12 |
| 20 | 10,000 | 356,062.12 | 36,606.21 | 402,668.33 |
| Sum | $150,000 |
Example 2: Investing $100,000 for 20 years
You can make a higher return on your investment if you invest heavily at the beginning. Suppose you invest $10,000 every year for the next 10 years in an ETF, which gives you a 10% annual return on your investment. In 20 years, you would have invested $100,000 but made a total of $454,713.32, which means you have increased your money by 4.5.
That means you have invested $50,000 less than Example 1 but made $52,044 more than example 1.
| Year | Deposit | Current Balance | Interest | Total |
|---|---|---|---|---|
| 1 | 10,000 | 10,000 | 1,000 | 11,000.00 |
| 2 | 10,000 | 11,000.00 | 2,100.00 | 23,100.00 |
| 3 | 10,000 | 23,100.00 | 3,310.00 | 36,410.00 |
| 4 | 10,000 | 36,410.00 | 4,641.00 | 51,051.00 |
| 5 | 10,000 | 51,051.00 | 6,105.10 | 67,156.10 |
| 6 | 10,000 | 67,156.10 | 7,715.61 | 84,871.71 |
| 7 | 10,000 | 84,871.71 | 9,487.17 | 104,358.88 |
| 8 | 10,000 | 104,358.88 | 11,435.89 | 125,794.77 |
| 9 | 10,000 | 125,794.77 | 13,579.48 | 149,374.25 |
| 10 | 10,000 | 149,374.25 | 15,937.42 | 175,311.67 |
| 11 | – | 175,311.67 | 17,531.17 | 192,842.84 |
| 12 | – | 192,842.84 | 19,284.28 | 212,127.12 |
| 13 | – | 212,127.12 | 21,212.71 | 233,339.83 |
| 14 | – | 233,339.83 | 23,333.98 | 256,673.82 |
| 15 | – | 256,673.82 | 25,667.38 | 282,341.20 |
| 16 | – | 282,341.20 | 28,234.12 | 310,575.32 |
| 17 | – | 310,575.32 | 31,057.53 | 341,632.85 |
| 18 | – | 341,632.85 | 34,163.29 | 375,796.14 |
| 19 | – | 375,796.14 | 37,579.61 | 413,375.75 |
| 20 | – | 413,375.75 | 41,337.57 | 454,713.32 |
| Sum | $100,000 |
Example 3: Investing $150,000 for 30 years
Suppose we keep investing $10,000 in Example 1 every year for the next 30 years with the same 10% return on investment or ROI. In 30 years, you will invest $250,000 and increase your wealth by $1,219,729.62.
| Year | Deposit | Current Balance | Interest | Total |
|---|---|---|---|---|
| 1 | 5,000 | 5,000 | 500.00 | 5,500.00 |
| 2 | 5,000 | 5,500.00 | 1,050.00 | 11,550.00 |
| 3 | 5,000 | 11,550.00 | 1,655.00 | 18,205.00 |
| 4 | 5,000 | 18,205.00 | 2,320.50 | 25,525.50 |
| 5 | 5,000 | 25,525.50 | 3,052.55 | 33,578.05 |
| 6 | 5,000 | 33,578.05 | 3,857.81 | 42,435.86 |
| 7 | 5,000 | 42,435.86 | 4,743.59 | 52,179.44 |
| 8 | 5,000 | 52,179.44 | 5,717.94 | 62,897.38 |
| 9 | 5,000 | 62,897.38 | 6,789.74 | 74,687.12 |
| 10 | 5,000 | 74,687.12 | 7,968.71 | 87,655.84 |
| 11 | 10,000 | 87,655.84 | 9,765.58 | 107,421.42 |
| 12 | 10,000 | 107,421.42 | 11,742.14 | 129,163.56 |
| 13 | 10,000 | 129,163.56 | 13,916.36 | 153,079.92 |
| 14 | 10,000 | 153,079.92 | 16,307.99 | 179,387.91 |
| 15 | 10,000 | 179,387.91 | 18,938.79 | 208,326.70 |
| 16 | 10,000 | 208,326.70 | 21,832.67 | 240,159.37 |
| 17 | 10,000 | 240,159.37 | 25,015.94 | 275,175.31 |
| 18 | 10,000 | 275,175.31 | 28,517.53 | 313,692.84 |
| 19 | 10,000 | 313,692.84 | 32,369.28 | 356,062.12 |
| 20 | 10,000 | 356,062.12 | 36,606.21 | 402,668.33 |
| 21 | 10,000 | 402,668.33 | 41,266.83 | 453,935.17 |
| 22 | 10,000 | 453,935.17 | 46,393.52 | 510,328.68 |
| 23 | 10,000 | 510,328.68 | 52,032.87 | 572,361.55 |
| 24 | 10,000 | 572,361.55 | 58,236.16 | 640,597.71 |
| 25 | 10,000 | 640,597.71 | 65,059.77 | 715,657.48 |
| 26 | 10,000 | 715,657.48 | 72,565.75 | 798,223.22 |
| 27 | 10,000 | 798,223.22 | 80,822.32 | 889,045.55 |
| 28 | 10,000 | 889,045.55 | 89,904.55 | 988,950.10 |
| 29 | 10,000 | 988,950.10 | 99,895.01 | 1,098,845.11 |
| 30 | 10,000 | 1,098,845.11 | 110,884.51 | 1,219,729.62 |
| Sum | $250,000 |
Example 4: Investing $100,000 for 30 years
In Example 2, if the same amount was left in that ETF for the next 30 years and assuming you are still making a 10% annual return, that $100,000 will grow to $1,179,409.26, which is 11 times more than what you have initially invested. If you compare it to example 3, you have invested $150,000 less and only lost $40,320 in return. This is the power of compound interest.
| Year | Deposit | Current Balance | Interest | Total |
|---|---|---|---|---|
| 1 | 10,000 | 10,000 | 1,000 | 11,000.00 |
| 2 | 10,000 | 11,000.00 | 2,100.00 | 23,100.00 |
| 3 | 10,000 | 23,100.00 | 3,310.00 | 36,410.00 |
| 4 | 10,000 | 36,410.00 | 4,641.00 | 51,051.00 |
| 5 | 10,000 | 51,051.00 | 6,105.10 | 67,156.10 |
| 6 | 10,000 | 67,156.10 | 7,715.61 | 84,871.71 |
| 7 | 10,000 | 84,871.71 | 9,487.17 | 104,358.88 |
| 8 | 10,000 | 104,358.88 | 11,435.89 | 125,794.77 |
| 9 | 10,000 | 125,794.77 | 13,579.48 | 149,374.25 |
| 10 | 10,000 | 149,374.25 | 15,937.42 | 175,311.67 |
| 11 | – | 175,311.67 | 17,531.17 | 192,842.84 |
| 12 | – | 192,842.84 | 19,284.28 | 212,127.12 |
| 13 | – | 212,127.12 | 21,212.71 | 233,339.83 |
| 14 | – | 233,339.83 | 23,333.98 | 256,673.82 |
| 15 | – | 256,673.82 | 25,667.38 | 282,341.20 |
| 16 | – | 282,341.20 | 28,234.12 | 310,575.32 |
| 17 | – | 310,575.32 | 31,057.53 | 341,632.85 |
| 18 | – | 341,632.85 | 34,163.29 | 375,796.14 |
| 19 | – | 375,796.14 | 37,579.61 | 413,375.75 |
| 20 | – | 413,375.75 | 41,337.57 | 454,713.32 |
| 21 | – | 454,713.32 | 45,471.33 | 500,184.66 |
| 22 | – | 500,184.66 | 50,018.47 | 550,203.12 |
| 23 | – | 550,203.12 | 55,020.31 | 605,223.43 |
| 24 | – | 605,223.43 | 60,522.34 | 665,745.78 |
| 25 | – | 665,745.78 | 66,574.58 | 732,320.36 |
| 26 | – | 732,320.36 | 73,232.04 | 805,552.39 |
| 27 | – | 805,552.39 | 80,555.24 | 886,107.63 |
| 28 | – | 886,107.63 | 88,610.76 | 974,718.39 |
| 29 | – | 974,718.39 | 97,471.84 | 1,072,190.23 |
| 30 | – | 1,072,190.23 | 107,219.02 | 1,179,409.26 |
| Sum | $100,000 |
The examples above show the benefit of investing in market-tracking ETFs. Investing early in your life can give you a high return if you keep your money invested for the long term. The important thing is that you have to invest consistently and keep your emotions in check regardless of the current market.
If that makes you excited? Then you should check the 9 Ways To Motivate Yourself To Invest In The Stock Market.
