If you're new to investing, it may seem intimidating to start out.
There's a lot of jargon in the stock market, and it may seem impossible to figure out what the best stock to buy is. Luckily, you don't have to take that approach, and if you're brand new to investing, buying exchange-traded funds (ETFs) is probably a better move.
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What are exchange-traded funds?
Exchange-traded funds hold multiple securities, generally stocks, but trade like a stock on the stock market. You might think of ETFs as the next evolution past mutual funds, which also hold a range of securities but are harder to buy and sell. They also tend to be more costly to hold than ETFs.
The first ETF was launched in 1993, the SPDR S&P 500 ETF (SPY -1.53%), tracking the S&P 500 (INDEX: ^SPX) index. The ETF helped popularize index funds, which are ETFs that track a stock market index like the S&P 500, Dow Jones Industrial Average, or the Russell 2000, which tracks small-cap stocks.
For an inexperienced investor, buying an ETF rather than individual stocks is the best move at least until you get more experience.
What's the best ETF for beginners?
If you're new to investing, starting out with an S&P 500 ETF makes sense as that will allow you to own all 500 of these stocks in the index. After all, the S&P 500 is so successful that most professional fund managers have trouble beating it.
The S&P 500 holds 500 large-cap stocks, meaning those with valuations above $10 billion. While they aren't necessarily the 500 most valuable American companies, they are 500 of the most valuable publicly traded American companies.
The S&P 500 also refreshes its holdings regularly, dumping underperforming stocks and adding growing companies, which is one reason for its long-term success. It's a constantly updating portfolio of the top American companies.
Over the long term, the S&P 500 has returned an annual average of 9% with dividends reinvested. That doesn't mean it will return 9% year in and year out as there's a lot of volatility on the stock market, but it shows the unmatched ability of the stock market to generate wealth.
If you assume that compound average growth rate (CAGR) holds into the future, a $1,000 investment in the S&P 500 would turn into nearly $2,400 after 10 years, $5,600 after 20 years, and nearly $13,300 after 10 years, showing the power of compound returns. Of course, continuing to invest after your initial investment will grow your money much faster than just watching one lump sum appreciate.
For example, if you continued to invest just $100 a month after that initial investment, you would have $198,000 after 30 years on just $36,000 in contributions.
What's the best S&P 500 ETF to buy?
For beginners, an S&P 500 ETF with strong long-term growth potential at a reasonable risk presents the most accessible option for investors.
But what's the best one to buy? They all deliver essentially the same returns, but the cost to own them differs from one to the next, and the Vanguard 500 Fund (VOO -1.52%) is one of the cheapest options out there. It charges investors an expense ratio of 0.03%. That means if you invested $10,000 in the Vanguard 500 Fund, you'd only pay $3 annually for the privilege of owning the ETF.
Considering the amount of time saved from not having to manage your own stock investments, that seems well worth the cost for both beginners and experienced investors alike. You'll also sleep easy knowing that the S&P 500 has an excellent track record of delivering for long-term investors through wars, economic crises, and even black swan events like the pandemic.
