Indexes and ETFs

As I mentioned in one of my launch posts, for me part of this journey is a learning one.  Thus from time to time I will post some information that I can easily look back on.

I don't have a lot of money to work with.  Thus for me, it makes sense to invest most of my money in funds vs. individual stocks.  (I'm still going to buy some individual stocks though!)

Currently, I have 3 mutual funds at Vanguard.  I've decided to switch to purchasing ETFs because the expense ratio is slightly lower (I get to keep more of MY money!) than in their mutual funds.  (The mutual funds are actively managed which means that although they are very similar to the ETFs Vanguard offers, you are effectively paying experienced asset managers to try to ensure that specific fund earns x% a year - generally speaking.  Thus the higher expense ratio is paying for those experienced asset managers.)

Needless to say those 3 mutual funds are going to just sit there and keep earning their dividends (which are reinvested).  Hopefully the value will grow over time.  But I don't need the money now so I am not going to sell them.

Exchange Traded Funds or ETFs (link to Investopedia) essentially trades like a stock but its purpose is to track an index.  (Mutual funds do not trade like stocks.)  Because ETFs trade like stocks, their value goes up and down throughout the trading day.  

Similar to mutual funds, ETFs own a bunch of stocks (or bonds or ...).  So by owning an ETF (or a share of an ETF) you indirectly own those stocks (or bonds or ...).  What an ETF owns varies.  For example, you can have an Energy ETF (owns only stocks of energy companies), or a Healthcare ETF (owns stocks of energy companies), or a Large Corporate Bond ETF (owns bonds from large corporations) or ...  There is so many options that can be underlying the individual ETF.  

My plan is to stick to simple ETFs that I can generally understand and identify what they own.

ETFs receive dividends (or interest) just like individual stocks so if you are invested in them, you will also receive a dividend.  If you own a Bond ETF, you are effectively earning interest since you indirectly own the bonds that the corporations issued.  (A bond is debt so think of it like a loan...)  Dividends (or interest) are paid either monthly or quarterly depending on the ETF.  

Vanguard offers its own ETFs as well as non-Vanguard ETFs.  The Vanguard ETFs are commission-free to buy and sell.  This is important to me as it saves me money on fees (I get to keep more of MY money!).  Because of this, I will only be buying Vanguard ETFs.

At $7/trade, the fees are expensive but in-line with several other brokerages.  Not paying that fee for an ETF is huge!  Because of this, when I do buy an individual stock, I need to try to buy more than one.  As an example, if I buy 1 stock that costs $100, the $7 fee is equal to 7% of what I paid.  But if I buy 2 stocks, then my fee per stock reduces to 3.5%.  

At least for the foreseeable future, I won't be able to buy more than a few stocks at a time.  Keeping this in mind, I will probably only buy one company at a time and at a maximum of 1 trade per month.  When I receive a bonus or a tax refund, then that is an opportunity for me to buy a lot of stocks at once.  But for ETFs, as long as I have the cash I can purchase them.

Generally, I expect to purchase either ETFs or individual stocks 2x per month.  Or when I get my paycheck.  I'll be using January to see how much I can allocate per check to investing.  Most likely one paycheck will be used to pay bills with the other one used primarily for investing/saving/paying-down-the-mortgage/funding other life goals.

Pru