What are ETF’s and How Can I Make Money with Them?

As you explore different investment opportunities you are bound to come across something
referred to as an “ETF” or “Exchange-Traded Funds”. Typically a more conservative investment,
it can be a fantastic way to get the benefits of investing in the market without as much risk of losing
all your money. There are some trade-offs when it comes to investing in an ETF but let’s
discuss more about why you would want to invest in one and what exactly you are investing in.

Why Choose an ETF

First, let’s discuss the difference between investing in an ETF and investing in a normal stock.
At a high level, when you buy a stock, you are purchasing a small part of ownership in that
company. When you purchase an ETF, you are buying a small portion of many different
companies. There are many different ETFs and each one is structured a little differently but
essentially when you buy an ETF you are purchasing a small portion of every company the ETF
is involved with. Where an ETF is beneficial is instead of having to make individual purchases
for each company you may want to invest in, you can find the right ETF for you and only
purchase it but take advantage of many different companies at the same time!

So what kinds of ETFs are out there? There are so many different ones out there and some
are still being created today. Some ETFs invest in energy companies, others
invest in the automotive industry, some invest in real estate, and some include every
company in the S&P 500. Every ETF will have a list of companies they own along with what
percentage of the ETF consists of that company. It’s normal to see many different companies
that only makeup 1 or 2% of an ETF.

Here is another way that an ETF could be a good investment option. Let’s say you believe that
solar energy is going to be huge in the next 5 years. With normal stocks, you would have to
research every solar company and figure out which one you wanted to “bet” on to take
advantage of any growth over the next few years. With ETFs, you could invest in all of them
equally and not worry about picking the “wrong” one. Companies can be in a field that
experiences growth and still go bankrupt, so ETFs help minimize those risks. If 1 company in
an ETF goes bankrupt, it is unlikely to drop the overall price of an ETF (since it probably only
consists of 1 or 2% of the entire fund). You must also consider the flip side of that statement
though when talking about growth. If only 1 company in an ETF increases in value, you are
unlikely to see a huge jump in the overall value of the ETF you are invested in.

How are ETFs Created

Let’s talk about how an ETF is created so we can discuss the “Price to Book” value or P/B. When
an individual or organization decides to create an ETF, they purchase the underlying stock and
put it into a fund. That fund then gets approved and becomes an ETF. This is an
oversimplification, but we’ll use it for illustrative purposes. So if this entity wanted to invest in
the automotive industry, they may buy millions of dollars worth of all the big automakers (Ford,
Toyota, Tesla, GM, etc.). Once they have purchased these stocks, they create an ETF under the ticker symbol “AUTO”. Now investors can purchase shares of “AUTO” for the price the fund
is worth divided by the number of outstanding shares (Ex: if the fund has $1,000,000 worth of
shares and there are 10,000 shares issued then each share would cost $100). Now once these
shares are purchased, they can be bought and sold on the market like any other stock and the
price can go up or down based on demand. Where it gets interesting is each share should only
be worth the value of the assets divided by the number of outstanding shares, but this
isn’t always the case. Price to book value tells us how much an ETF is trading at compared to
its actual value. If an ETF is trading in the negative, then shares are less than what they are
worth. If they are in the positive, then shares are overvalued.

Should I Invest?

So what should you look out for when investing in an ETF? You should always check on fees
and commissions and ensure you aren’t paying too much. Most ETFs are passively managed
so fees should be on the lower side compared to actively managed funds. Another thing is to
look at the mix of companies and the percentage of ownership of each. Some ETFs have different
percentages for each company and others try to keep them all equal (this is important because
if an ETF has a higher level of ownership in one company, the fund is more likely to go up or
down based on that company). You should also look at whether the ETF pays a dividend or not.

There are many great ETFs out there and we would encourage you to research them as they
can be great additions to any investment portfolio. Some examples would be VOO (probably
one of the most popular ETFs that invest in the entire S&P 500), NOBL (contains companies
that are “Dividend Aristocrats” or companies that have increased their dividend payments every
year for at least 25 years), CARZ (as opposed to the fictitious example “AUTO” used above,
CARZ is an actual automotive ETF), USA (a more technology-heavy ETF that aims to pay about
a 10% dividend every year) and SPY (An ETF similar to VOO that matches the S&P 500). Just
like any investment, however, there is always a risk that you could lose value so please make
sure you do your research before investing in any ETF.