Why ETF Investing Is Ideal for Young Investors

Exchange-traded funds (ETFs) have a number of features that can make these investment vehicles ideal for young investors with small amounts of capital to invest. They're also great for young people who may not have a lot of investment knowledge.

Exchange-traded funds make it possible to build a diversified portfolio with relatively low investment amounts. They also trade throughout the day, providing ample liquidity, and many have relatively low-cost structures. In fact, there are at least five reasons why young investors might want to consider ETFs for potential investment opportunities.

1. Variety

The first ETFs were introduced in the late 1980s and early 1990s. These relatively simple products tracked equity indexes such as the S&P 500 and the Dow Jones Industrial Average (DJIA). Since then, ETFs have expanded to include practically every asset class from stocks, bonds, real estate, commodities, currencies, and international investments along with every sector and niche area imaginable.

The ETF market is highly competitive among issuers. This means there are very focused ETFs that young investors can choose from that track particular markets or segments that may appeal to them. As of Nov. 2023, there were 3,076 U.S.-based ETFs open for investors to trade. For young investors, this extensive range of available ETFs offers a wide variety of investment choices.

Because there are so many options, an investor can build a diversified portfolio with a lower amount of capital. Consider the case of a young investor with $2,500 to invest. Let's assume that this investor is knowledgeable about financial markets and has views on specific investments.

They are optimistic about U.S. equities and want U.S. stocks to be their core investment position. They also want smaller positions to go along with their bullish views on gold and the Japanese yen, expecting both to move higher.

While this portfolio would have required more capital in the past (especially before the advent of commodity and currency ETFs), the investor can build a portfolio incorporating all views through the use of ETFs with just $2,500. They may choose to invest $1,500 into the SPDR S&P 500 ETF Trust (SPY) and $500 in both the SPDR Gold Fund (GLD) and the Invesco CurrencyShares Japanese Yen Trust (FXY).

2. Liquidity

ETFs are just like stocks. This means you can buy and sell shares of an ETF the same way you would for any U.S. stock, such as a blue chip or small-cap company. This means that these investments are highly liquid and can be traded throughout the day.

Because of their liquidity, ETF investors have a major advantage over index mutual funds, which are priced only at the end of the business day. As such, it's an especially critical differentiating factor for the young investor, who may want to exit a losing investment immediately to preserve a limited amount of capital.

Ample liquidity also means that investors can use ETF shares for intraday trading, similar to stocks.

3. Low Fees

Investments cost money. The fees associated with investment vehicles pay investment firms, portfolio or fund managers, and advisers. Some investments charge their clients exorbitant fees while others come with modest costs. Fees can be called expense ratios, management fees, or commissions.

Exchange-traded funds generally have lower expense ratios than mutual funds. Although they can be bought and sold like stocks, many online brokers offer commission-free ETFs, even for investors with small accounts. This can be a big help to young investors, as high fees and commissions could really put a dent in their account balance.

4. Investment Management Choice

ETFs enable investors to manage their investments in the style of their choice, whether that's passive, active, or somewhere in between. Passive management, or index investing, simply involves building a portfolio to mimic one or more market indexes, while active management entails a more hands-on approach and the selection of specific stocks or sectors in a bid to beat the market.

Young investors who are not very familiar with the intricacies of the financial markets would be well-served by using a passive management approach initially and gradually moving to a more active style as their investing knowledge increases.

Sector ETFs enable investors to take bullish or bearish positions in specific sectors or markets. Inverse ETFs trade in the opposite direction of an asset or market while leveraged ETFs magnify results by two or three times. Both of these options make it possible for investors to incorporate advanced portfolio management strategies.

5. Keeps Up With Trends

One of the principal reasons for the rapid growth of ETFs is that their issuers have been at the leading edge in terms of introducing new and innovative products.

ETF issuers generally responded rapidly to the demand for products in hot sectors. For example, many commodity ETFs were introduced during the commodity boom between 2003 and 2007. Some of these ETFs tracked broad commodity baskets, while others tracked specific commodities such as crude oil and gold.

The dynamism and innovation displayed by ETF issuers are likely to appeal to young investors. As new investment trends get underway and demand surfaces for even newer investment products, there will undoubtedly be ETFs introduced to meet this demand.

The Bottom Line

ETFs are a great way for people to test the investment waters. Young investors who are not familiar with the intricacies of the financial markets might be well-served by investing in an ETF that tracks the broader market.

Sector funds enable investors to take bullish or bearish positions in specific sectors, while inverse ETFs and leveraged ETFs make it possible to incorporate advanced portfolio management strategies. Some other characteristics of ETFs that make them ideal investment vehicles for young investors include diversification, liquidity, low fees, investment management choice, and innovation.