I have a small taxable account that I’ve slowly built up with my “fun money” – $25/month. It’s only got $550 in it at the moment – not enough to buy an index mutual fund now nor or in the near future. But, I like to invest in low cost index funds. How can I do that when I don’t have the minimum to buy into one?
Exchange Traded Funds
Enter ETFs. ETFs are sort of mutual funds, sort of stocks. They’re traded throughout the day, and so are priced “instantaneously” vs end of the day like mutual funds. They have some of the benefits of mutual funds, but some of the risks of stock trading (most notably, buy-ask spread). Some are low cost, others are very high cost – just like mutual funds. Actively managed ETFs are more expensive than passive index based ones as you’d expect.
The best part – you can buy just one share. As long as you have at least the value of the share plus any trading fees in your account, you can buy a share. Fidelity (at least) offers a lot of no trading fee (NTF) ETFs – mostly in the iShares line of ETFs – so, for the cost of a “share”, I can invest in an index ETF.
The biggest disadvantage is that I can only buy whole shares (at least at Fidelity). That means that I have some money sitting in the “Cash” bucket not really working for me like it could be in a fractional share of a mutual fund.
This is a taxable account, and is kind of my “playground”, even if it’s not a very big one. Every 3 months, I transfer $75 into my Fidelity account – a decent amount to be able to afford most ETFs I want. Then I buy one of ITOT, IDV or HDV. This allows me to dabble in dividend investing for less than buying stocks outright (and less research required!), yet still be primarily index investing. How did I pick those? I looked at all the ETFs Fidelity offered that had no trading fee and an expense ratio of 0.5% or lower (use their ETF picker). These looked interesting.
When I have the minimum $2500 to invest in the index mutual funds I prefer, I’ll likely sell the ETFs and buy the mutual funds, but at my current investment rate, that’s still a few years off. Once all of our tax-advantaged accounts are maxed out, this account will begin to see more cash flowing into it, but it will likely be next year at the earliest that I can consider mutual funds.
Here is where my general ignorance in investing hurts me. I’m not even able to say definitively whether it’s better for me to invest in index ETFs (apparently they have some tax advantages) or in index mutual funds (love being able to buy in accordance with my AA, rather than having to buy in whole shares, leaving cash un-invested, etc.).
But when we did use ETFs with Fidelity, it was for the same reason you noted: we just didn’t have enough invested yet to buy into the mutual funds we wanted to.
The only tax advantages I’m aware of with ETFs is that they don’t automatically re-invest any dividends, and capital gains aren’t “passed through” to you until you sell the ETF and realize a gain (or loss) – whereas mutual funds cause you to realize the gain (loss) throughout the year. I’m still at that point where $5/year in dividends doesn’t make a huge difference for me in taxes 🙂
I invest mainly in index funds via my 401k plans and Roth IRAs, but I do have one small account that I use, like you say, for “fun money.” This is the one where I allow myself to value the stocks and make individual picks. I usually end up with blue chips in it, but like Done By Forty, I think I really need to learn more about ETFs.
I was “suckered in” with the Fidelity advertising enough to read more about them, then decided that they were a good option for me given my limited time to really research and evaluate stocks (and probably still do worse than the whole market). Fidelity actually has a pretty decent ETF primer: https://www.fidelity.com/learning-center/investment-products/etf/what-are-etfs And of course, investopedia does as well: http://www.investopedia.com/exam-guide/cfa-level-1/alternative-investments/etfs-exchange-traded-funds.asp I’d encourage you to research them well before investing in them. Thanks for stopping by!
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