Skip to main content

Choosing Your First ETF

🌟 From Strategy to Action: Your First Practical Step​

In our last article, we identified three simple, powerful, and lasting investment strategies. Now, it's time to take the final, practical step and turn your chosen strategy into a real investment. For most people, the best, most efficient, and lowest-cost tool to do this is the Exchange-Traded Fund, or ETF. An ETF is a basket of stocks (or bonds) that you can buy and sell in a single transaction, just like a single stock, but it offers the instant diversification of a mutual fund. This article will provide a simple, practical, step-by-step guide to choosing your first high-quality, low-cost ETF.

Step 1: Choose Your Core Strategy (The "Why")​

Before you can choose an ETF, you must know why you are investing. This is the most important step. Refer back to our last article and decide which of the three simple strategies aligns with your long-term goals.

  • Strategy A: Broad Market Index Investing. Your goal is to own the entire market (or a large slice of it), capture its average long-term return, and be as diversified as possible. You are looking for a broad market index ETF, like one that tracks the S&P 500 or the total U.S. stock market. This is the classic "own the haystack" approach.
  • Strategy B: Dividend Growth Investing. Your goal is to own a basket of high-quality, consistently profitable companies that pay you a rising stream of income. You are looking for a dividend growth ETF. This is the "get paid to wait" approach.
  • Strategy C: Thematic Investing. Your goal is to make a more concentrated investment in a specific long-term macro trend you believe in. You are looking for a thematic ETF (e.g., robotics, clean energy, cybersecurity, etc.). This is the "invest in what you see" approach.

This initial choice is the most important one you will make. It will narrow down the universe of thousands of available ETFs to a manageable handful that are right for you.

Step 2: The Three Most Important Letters in Investing: "E. X. P."​

When comparing similar ETFs that track the same index or follow the same strategy, the single most important factor for your long-term returns is the Expense Ratio (EXP). This is the small annual fee that the fund manager charges to operate the fund. It is expressed as a percentage of your total investment.

It may seem like a small, insignificant number, but the difference between a 0.03% expense ratio and a 0.75% expense ratio can translate into tens or even hundreds of thousands of dollars in lost returns over a lifetime of investing due to the negative power of compounding fees.

  • Your Goal: For a simple, broad market or dividend ETF, you should look for an expense ratio of 0.10% or lower. The competition among major ETF providers (like Vanguard, BlackRock, and Schwab) is so fierce that you can now get broad market exposure for almost free.
  • For more specialized thematic ETFs, you may have to pay a bit more (e.g., 0.40% to 0.75%), but you should still seek out the lowest-cost and most efficient option in that specific category.

Always, always choose the lowest-cost fund when all else is equal. This is the closest thing to a free lunch in the world of investing.

Step 3: Check the Size and Liquidity (AUM and Volume)​

Once you've narrowed down your choices by strategy and cost, you want to make sure the ETF is large and actively traded enough to be stable and easy for you to buy and sell.

  • Assets Under Management (AUM): This is the total amount of money that all investors have put into the fund. As a general rule, look for ETFs with at least a few billion dollars in AUM. This indicates that the fund is well-established, trusted by many investors, and very unlikely to be closed down by the provider.
  • Average Daily Volume: This tells you how many shares of the ETF trade hands on an average day. A higher volume means the ETF is more "liquid," which makes it easier to buy and sell at a fair price with a very small "bid-ask spread." For large, popular ETFs, you should look for an average volume of at least a few hundred thousand shares per day.

You can find the Expense Ratio, AUM, and Average Volume on the "Summary" or "Quote" page for any ETF ticker on free websites like Yahoo Finance, Morningstar, or directly on your brokerage's website.

Step 4: Look Under the Hood (The "Holdings")​

The final step before buying is to take a quick look at what the ETF actually owns. On the ETF's quote page online, there will be a tab for "Holdings" or "Portfolio." You don't need to analyze every single stock, but you should check two things on the "Top 10 Holdings" list.

  • Does it match your strategy? If you're buying an S&P 500 index fund, the top holdings should be the largest and most famous companies in the U.S. (like Apple, Microsoft, and Amazon). If you're buying a dividend ETF, the top holdings should be large, stable, dividend-paying companies (like Johnson & Johnson, Procter & Gamble, or Coca-Cola). This is a simple sanity check.
  • Is it well-diversified? For a broad fund, the top 10 holdings will likely make up 20-30% of the total fund. This is normal and reflects the market-cap weighting of the index. However, if a single stock makes up a huge percentage of the fund, you should be aware of that concentration risk.

Putting It All Together: Some Common, High-Quality First ETFs​

Here are a few examples of high-quality, low-cost ETFs that are popular choices for each of the strategies we've discussed. (This is not a specific recommendation, but an illustration of the principles in action).

  • For Broad Market Index Investing (S&P 500):
    • Vanguard S&P 500 ETF (VOO) - Expense Ratio: 0.03%
    • iShares CORE S&P 500 ETF (IVV) - Expense Ratio: 0.03%
  • For Dividend Growth Investing:
    • Schwab U.S. Dividend Equity ETF (SCHD) - Expense Ratio: 0.06%
    • Vanguard Dividend Appreciation ETF (VIG) - Expense Ratio: 0.06%
  • For Thematic Investing (Example: Robotics & AI):
    • Global X Robotics & Artificial Intelligence ETF (BOTZ) - Expense Ratio: 0.68%

Notice that all the core index and dividend funds listed have rock-bottom expense ratios well below 0.10%. The thematic fund is more expensive, which is typical for a specialized strategy.

💡 Conclusion: Don't Let "Perfect" Be the Enemy of "Good"​

Choosing your first ETF can feel daunting given the thousands of options. But it doesn't have to be. By following these simple, logical steps—clarifying your strategy, ruthlessly minimizing costs, ensuring the fund is large and liquid, and taking a quick look at its holdings—you can confidently select a high-quality investment that will serve you well for decades to come. The most important step is not to spend months searching for the "perfect" ETF, which doesn't exist. The most important step is to choose a great, low-cost option and get started on your investing journey.

Here’s what to remember:

  • Strategy first, ETF second. Know why you're investing before you decide what to invest in.
  • The Expense Ratio is the most important number you will find. Minimize it above all else for your core holdings.
  • Size and liquidity matter for stability and ease of trading. Stick with large, well-established ETFs from reputable providers.
  • A quick look at the top 10 holdings is a good final sanity check to ensure the ETF does what you expect it to do.

Challenge Yourself: Using a free tool like Yahoo Finance or your own brokerage's ETF screener, pick one of the core strategies from our last article (Index or Dividend Growth). Now, try to find two or three different ETFs from different providers (e.g., Vanguard, iShares, Schwab) that fit that strategy. Compare their Expense Ratios, AUM, and Top 10 Holdings. Can you see why one might be a slightly better choice than another? This simple exercise will build your confidence in analyzing and selecting funds.

➡️ What's Next?​

You've learned how to choose a simple, effective, and low-cost tool to put your investment strategy into action. In our next article, "Designing Your Own Investor's Plan," we'll pull everything together from the entire book. We'll guide you through creating a simple, one-page document that will define your goals, your strategy, and your rules, serving as your personal roadmap for your entire investing journey.

📚 Glossary & Further Reading​

Glossary:

  • ETF (Exchange-Traded Fund): A type of investment fund that is traded on a stock exchange, like a stock. It holds a basket of assets, such as stocks or bonds, providing instant diversification.
  • Expense Ratio (EXP): The annual fee that all funds or ETFs charge for their services, expressed as a percentage of your investment.
  • AUM (Assets Under Management): The total market value of all the investments that a fund manages on behalf of all its investors.
  • Liquidity: The ease with which an asset, or security, can be converted into ready cash without affecting its market price. High trading volume is a sign of good liquidity.

Further Reading: