*Disclaimer: not investment advice, educational purposes only
If you ready to start investing in ETFs or Index Funds but aren’t sure what to look for when selecting the best investment for you, look no further.
When I am looking for a new investment, I start by reviewing the average return, then review the associated expenses (or management fees), any barriers to entry like a high minimum investment and understanding the tax implications
Average Annual Return
Average Annual Return (or AAR) is basically just how the fund has performed inclusive of interest and dividends over a set period of time. It is popular to look at it in terms of 1,3,5, and 10 years. It is important to look at the average return for a little longer term period as not every year will be same and there will be fluctuations in the market but you want to understand on average what it returns given the good days and the not so good days in the market.
For reference, The S&P 500, tends to return approximately 7% per year including impacts from inflation
Let’s look at VTI for example. If you look at Vanguard’s website, you search for VTI (Total Stock Market ETF) you can find the fund’s average annual return here
It is important to view the return over a longer time period as periods of high growth tend to skew the return. 2020 was an incredible year for the stock market, however it is important to note that it is not always the case. But, the good periods in the market offset some of the bad ones
Expense Ratio
When you are investing into a Mutual Fund or ETF, you pay a fee to have someone else manage the fund. In return for managing the fund, the investment manager gets paid a small percentage of your portfolio. You want the lowest expense without sacrificing returns to keep as much money as you can.
Passive funds that track an index will have a much lower expense ratio as these are simply mirroring an index like the S&P 500 or Total Stock Market rather than actively trading and trying to beat the market. For example, an actively traded fund can cost you about 1% per year vs. a passively traded fund may be as low as 0.02%.
While 1% still seems pretty minimal, those fees can add up significant over time as the continue to compound.
Minimum Investment
Some funds tend to have a minimum investment to buy into it, so if the fund you are looking at does, make sure you can meet the minimum required investment. As a note, this is only applicable to mutual funds as ETFs are trading on a share basis so there is no minimum.
Personally, I try to pick funds with very low minimum investments or 0 so I can make small contributions as often as I want.
For example, VTSAX is a popular Mutual Fund Index Fund from Vanguard that tracks the Total Stock Market Index. This fund has a minimum investment of $3,000, so if you only have $1000 ready to invest and you want to invest through a mutual fund you can opt for a lower or no minimum investment
If you still want to invest on a cost basis rather than on a share basis but don’t want to invest $3,000, Fidelity offers no minimum investment index funds like FSKAX (alternative to VTSAX). You can find the full list here.