You should aim for a diversified portfolio, but instead of going as broadly as possible, it pays to use certain index ETFs to focus your investment.
You don’t need to have years of experience to invest in stocks. That’s both a blessing (anyone can do it) and a curse (the risk is usually higher if you’re not sure what you’re doing).
That said, there’s a way for you to safely invest and learn at the same time using exchange-traded funds (ETFs) that are tied to major indexes. But it may pay to be just a little discerning with the ETF you buy. Here’s why.
The Vanguard Total Stock Market ETF is the everything fund
One of the first things you should wrap your head around when it comes to investing is that you are going to make mistakes. Everyone does, even Wall Street legends like Warren Buffett. The goal is to minimize the impact that your mistakes have on your portfolio. The way you do that is through diversification.
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Diversification simply means spreading your bets around or not putting all your eggs in one basket. New investors may be tempted bet big on one stock thinking it can turn them into a millionaire, but a get-rich-quick mentality often leads to heartache. Luckily, there’s an easy way to diversify in the stock market: exchange-traded funds. And one of the most popular options is the Vanguard Total Stock Market ETF (VTI 0.43%).
This ETF tracks a broad swath of U.S. stocks with a portfolio of more than 3,650 securities. It is market-cap weighted, so the largest companies drive the fund’s performance. The largest holding in the ETF, Apple, makes up about 6% of assets, and other Magnificent Seven companies round out the top five.
The expense ratio for this ETF is just 0.03%, which is as close to free as you can get on Wall Street.
This isn’t a bad option, but most new investors will probably be better off with something a little more selective.
Enter the S&P 500 index
Instead of buying nearly everything, you can cherry pick the 500 biggest companies that, as a group, are most representative of the U.S. stock market. And the ETFs tracking the S&P 500 index, such as the Vanguard S&P 500 ETF (VOO 0.43%) or the SPDR S&P 500 ETF (SPY 0.42%), are the most popular options on the market.
If you go this route, you’re honing in on the most important companies while still getting the benefit of diversification as a new investor.
The two options highlighted above are very similar with one main difference: The Vanguard S&P 500 ETF’s 0.03% expense ratio is lower than the SPDR S&P 500 ETF’s 0.09%. That’s a big difference percentage wise but minor on an absolute basis.
Jump in with both feet (once you have a life preserver)
With both of these ETFs, you’re effectively buying the S&P 500 index, which is often used as a benchmark for the stock market overall. And with this solid foundation for your portfolio, you can consider potential next steps in your investing journey.
That could mean finding a stock you like and learning about it by going to the company’s website, reading its news releases or filings, and listening to management’s earnings calls. Eventually, you may decide to take a small position in an individual stock. Or you may decide to stick with ETFs but find ones with a focus on specific sectors or themes.
The key here is to start investing as early as possible because time plays an important role in your success in the market.
Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple, Vanguard S&P 500 ETF, and Vanguard Total Stock Market ETF. The Motley Fool has a disclosure policy.