After contemplating starting the investment journey, it can take days, weeks, months, or even years before a potential investor decides to take action. The first thing that stops them from acting sooner might be the fact that it can be difficult to make a choice.

If you’re one of those who have difficulty choosing how to invest, index exchange-traded funds (ETFs) might be a good place to start.

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Takeaways

• Benchmark indexes reflect the movement of the stock market.
• Index ETFs track an index by holding stocks included in the index, thus generating returns roughly equal to the price change of the index.
• ETFs trade like stocks and can generate dividends. Their expense ratios are low compared to other types of funds.

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The Three Benchmark Indexes in the U.S.

If you’re interested in investing, you should know about the three benchmark indexes in U.S.—S&P 500, Dow Jones, and Nasdaq Composite.

• The S&P 500 represents approximately 80% of the total value of the U.S. stock market. It’s a good indication of the US stock market as a whole.
• The Dow Jones Industrial Average is known for its composition of large blue chip companies with consistent dividends.
• The Nasdaq Composite Index consists of all the stocks traded on Nasdaq, many of which are technology stocks.

We usually quote the movements of the three indexes when we say the stock market is up or down.

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Index ETFs

Unlike an individual stock, an index does not allow investors to buy/sell directly, which gives birth to index ETFs and many index derivatives.

Index ETFs try to track the performance of the index by holding a portfolio of the common stocks included in the index. In this way, investors can expect a return roughly equal to the price change of the index.

• For example, $Spdr S&P 500 Etf tracks the S&P 500 Index (SPX) by holding all members of the underlying index at their target weights. Its share price is intended to be 1/10th of the index. As we can see below, the price changes of the two have been highly consistent over the last 4 years (July 2018 to July 2022).

• Among multiple ETFs that track Nasdaq indexes, the most famous one is $Invesco QQQ Trust. It tracks the Nasdaq-100 Index (NDX), which comprises 100 of the largest non-financial companies included in the Nasdaq Composite Index. It currently trades at approximately 1/40th of the value of the NASDAQ-100 Index. Over the last 4 years (July 2018 to July 2022), QQQ has closely followed the movements of the Nasdaq-100 Index.

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Benefits and Risk Considerations

Before you make your first investment in index ETFs, you should understand their advantages as well as risks.

People usually buy index ETFs for the following reasons:

1. Index ETFs offer exposure to benchmark indexes.
2. ETFs trade throughout the day just like stocks.
3. Just like other funds, ETFs have expense ratios. But the expense is much lower, usually no more than 1%. It’s not hard to find index ETFs with an expense ratio as low as 0.03%.
4. ETFs give out dividends if their holdings generate dividends.

Below are the risks to consider before you take any action.

1. Trading index ETFs generate risks as great as trading stocks.
2. While 1x ETFs seek 100% exposure to indexes, leveraged ETFs seek a few times the exposure. Do not play with leverage until you’re ready.

Index ETFs with similar symbols can be confusing. Here we’ve prepared a list of them so that you can see the difference.

What's More

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