Many people want to end up as a millionaire, but they think they have to have a “get rich quick” scheme in order to obtain that level of wealth. However, the reality is that it’s also possible to grow a tremendous amount of wealth without doing a lot of work at all and without taking a lot of risk. If that sounds like a good option to you, then it literally pays to look at an ETF such as Vanguard S&P 500 ETF (NYSEMKT:VOO) or The SPDR S&P 500 (NYSEMKT:SPY).
What is an ETF?
And ETF is an exchange traded fund and making money from ETFs is essentially the same as making money by investing in mutual funds because they operate same way. However, the main difference between the two is that ETFs are actively traded at intervals throughout a trading day, where mutual funds are traded at the end of the trading day.
The way your ETF makes money depends on the type of investments it holds.
ETF’s may be composed of stocks, bonds, or commodities such as gold or silver or it might attempt to track the performance of an index such as the Dow Jones Industrial Average or the S&P 500.
Well-known investor Warren Buffet is fond of advising the everyday investor to invest in an index fund, based on overall performance longevity and long-term stability. Returns are a combination of growth—an increase in the price of the stocks your ETF owns—and income from dividends paid out by those same stocks that are being tracked within an ETF.
When an ETF is purchased, an investor owns a small portion of shares in multiple companies rather than searching out individual company shares to purchase. If you are using a brokerage account, this can keep transaction costs down since one transaction expense is lower than multiple transactions.
Because an ETF consist of multiple companies, an investor’s portfolio becomes diversified without having to research a lot of companies and helps an investor lessen the overall risk involved in investing.
Investments are taxed in different ways—ETFs generally have fewer capital gains than mutual funds, and are taxed only when the ETF is sold by the investor. Mutual funds capital gains, in comparison, are taxed throughout the lifetime of the fund—which increases the amount of taxes paid on the investment.
ETF liquidity is the ability to turn an asset into cash—in this case it is the ability to sell ETFs. ETFs can be traded throughout the day, which allows an investor to purchase or sell shares of an ETF rather quickly and easily when compared to other investment types.
If an ETF pays dividends, they will be taxed as ordinary income unless they meet the requirements to become qualified dividends—the qualification of which is to be held by the trader for more than 60 days during the 121 day period that begins 60 days before the ex-dividend date—at which time they receive the lower tax rate of capital gains.
While there are a few ETFs that offer higher yields, by design they carry lower risk than individual stocks, so dividends are generally lower.
ETF index funds are designed to track the performance of a stock market index, such as the S&P 500. Tracking error is the difference between an index fund’s performance and the performance of the index. Generally, this is caused by the fund’s management because they are not managing the fund correctly. This mismanagement then leads to claims of performance by the fund’s managers to continue to attract investors and traders.
You should not invest in ETF’s that you don’t understand. ETF’s are comprised if other assets, such as stocks. As you are looking for ETFs to purchase, be sure to read both the ETF’s summary to understand what the ETF actually holds as far as the assets in which the ETF is diversified.
Work to comprehend the historical performance and returns in different types of market conditions, look at different investment strategies, and understand the risks that the fund presents. Some ETFs utilize super leverage (high debt) and short stocks (borrowed to sell), while others concentrate heavily in specific sectors or industries.
Heavily concentrated ETFs come with higher risk—if the market or industry the ETF is concentrated in collapses or experiences downturns, the entire fund will be affected, with disastrous results.
As Warren Buffett is fond of saying, the first rule of making money is to never lose money. You should know the exact underlying holdings of each ETF you own.
Try to keep your ETF expenses reasonable. This generally isn’t a major problem because ETFs tend to have expenses that are very affordable—it’s one of the reasons they’re frequently preferred by investors who can’t afford individually managed accounts. But ETF expenses nonetheless include management fees, annual fees, and brokerage commissions, among other costs.
A financial planner, financial advisor, or do-it-yourself investor can cobble together a portfolio of reasonably diversified holdings, even picking up similar ETFs that focus on individual sectors or industries for an expense ratio in the neighborhood of 0.50% per annum.
Focus on the Long Term
ETFs should ultimately perform roughly in-line with their underlying holdings, short of some sort of structural problem or another low-probability event. This means that you might be subject to fairly horrific swings in market value in any given year if you hold an equity exchange-traded fund. You might see periods similar to 2007–2009 when ETF holdings drop by 20% or more.
The upside of investing in the S&P 500 ETF
The S&P 500 index consists of the 500 largest publicly traded companies, so it’s a great representation of the broad market. When you invest in the S&P 500, you don’t just add quality stocks to your portfolio — you also get instant diversification.
The Vanguard S&P 500 ETF tracks the S&P 500. (If you’re not familiar with ETFs, that’s short for exchange-traded funds. These funds follow different market indexes and let you scoop up a bucket of stocks with a single investment. It really doesn’t get more convenient than that.)
Now the bad news is that the fund’s goal isn’t to beat the S&P 500. The good news, however, is that the S&P 500 has had a strong performance over time, and so matching it is a good benchmark to aim for. In fact, the Vanguard S&P 500 ETF has delivered an average annual 15% return since its inception.
How a single ETF could make you a millionaire
The Vanguard S&P 500 ETF is a great choice as an investment, but let’s be clear — you’ll need to stick with it for a long time for it to turn you into a millionaire.
But let’s assume you put $10,000 into that ETF and leave your money alone for 35 years. If that 15% average annual return holds, you’ll wind up with $1.33 million. Keep your $10,000 invested for 40 years, and you’ll be looking at almost $2.7 million.
Of course, not everyone has $10,000 on hand to sink into a single ETF. So let’s say that instead of a lump sum investment, you buy shares over time. If you invest $100 a month over 35 years, you’ll wind up with just over $1 million — again, assuming the fund delivers that same average annual 15% return during that window.
There’s no guarantee the future will look like the past, but time generally irons out most of the volatility, and investors have been well-rewarded. The thing to remember is that ETFs are like any other investment in that they are not golden eggs. They are investing tools that should be used to build a diverse portfolio while mitigating risk—nothing more, nothing less.
My recommendation is to start A Robinhood account (or use another platform if you aren’t into Robinhood. I prefer it because it is easy to use, I love the mobile app – which allows me to buy and sell quickly. From there, make sure to fund your account with some money so that after you do your research you can purchase your first ETF. The key here is to make sure you do your own research on ETFs in industries or markets that you are interested in. If you enjoyed this post, then please hit the like button and subscribed to my page so you can be notified when my newest investing posts are published.
Thanks for stopping by,
Disclaimer: I do not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.
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