Best ETFs for Young Investors: A Guide to Choosing Funds

Best ETFs for Young Investors: A Guide to Choosing Funds

See why ETFs can be wise investments for young investors and learn how to choose the right ones.

kent
|
Research Lead
Reviewed by: etf.com Staff
,
Edited by: Ron Day

Exchange-traded funds offer several advantages for young investors: they provide instant diversification across a basket of stocks with a single purchase, reducing risk compared to picking individual stocks. Low expense ratios minimize fees, and ETFs trade like stocks, allowing for easy and potentially commission-free investing. This allows young investors to start building wealth early and benefit from the power of compounding over the long term.

Learn more in our young investors guide to choosing the best ETFs to hold in a long-term portfolio. 

Steps for Choosing the Best ETFs for Young Investors 

Although young investors can generally accept more market risk compared with older investors, the strategy for choosing the best ETFs is similar for all investors. These steps begin with identifying a time horizon and risk tolerance, which will guide the asset allocation and specific ETF selection for the portfolio. 

Typical steps for choosing the best ETFs for young investors include: 

  1. Identify your time horizon 
  2. Gauge your risk tolerance 
  3. Determine your asset mix 
  4. Select types of ETFs 
  5. Choose the best ETFs for you 

Identify Your Time Horizon 

Young investors are most likely to be long-term investors, which can be defined as investors who have a time horizon of 10 years or more before beginning withdrawals from their investments. Generally, the more time you have until you need to begin making withdrawals from your investment account, the more risk you can take. 

For example, if you are investing for retirement and you believe you are at least 30 years away from that goal, you can take more risk than an investor who is just 10 years away from retirement. Taking on more risk generally means investing more in stocks than more stable investment assets like bonds. 

Gauge Your Risk Tolerance 

Risk tolerance is a measure of how much risk an investor is comfortable taking with their investments. Risk can be measured by volatility or the degree that an investment security’s price moves up and down. So, the higher your risk tolerance, the more volatility you are willing to accept without panicking and selling your investments. 

It’s important to understand that there is a direct relationship between risk and return. For example, the more risk you are willing to take, the greater the potential return in the long run. However, in the short term, high-risk investments, such as stock ETFs, can see greater volatility than lower-risk investments, such as fixed income ETFs.  

To assess risk tolerance, many brokers and fund companies offer risk tolerance questionnaires to their account holders. Investment advisors will also assess risk tolerance for their clients before recommending an asset allocation and investment selection. 

Risk tolerance may be broadly categorized as either aggressive, moderate or conservative: 

  • Aggressive investors: want to outpace the average rate of inflation by a wide margin and are comfortable with wide short-term fluctuations in the price of their investments, in exchange for the potential to achieve high long-term returns. 
  • Moderate investors: want to outpace inflation by a moderate degree, and don’t mind some fluctuations in the value of their portfolios. 
  • Conservative investors: want to match or slightly exceed inflation and prefer stable returns. 

Determine Your Asset Mix 

An investor’s asset mix, or asset allocation, is the mix of primary investment assets, such as stocks, bonds and cash, to be used in a portfolio. The asset mix is a direct reflection of the investor’s time horizon and tolerance for risk, and can be broadly defined as aggressive, moderate or conservative. 

The asset mix will be defined by allocation percentage weights. Young investors can afford to choose an aggressive asset mix, which may be appropriate for investors with a long-term time horizon and high tolerance for market risk. However, if the investor has a lower tolerance for risk, they may choose a moderate or conservative asset mix. 

Example portfolio asset allocations are: 

  • Aggressive portfolio allocation: 70-90% stocks, 10-30% bonds 
  • Moderate portfolio allocation: 50-70% stocks, 30-40% bonds, 0-10% cash 
  • Conservative portfolio allocation: 20-40% stocks, 40-50% bonds, 10-40% cash

Tip: For help in building a portfolio, see our Portfolio Builder tool.

Select Types of ETFs 

Before choosing the best ETFs for a portfolio, an investor will need to determine which types of ETFs are most appropriate for their goals. Many investors will have a mix of equity (stock) ETFs and fixed income (bond) ETFs. Within those primary asset classes, investors may choose more defined styles, such as market capitalization for stocks or duration, and credit quality for bonds. 

The types of stock ETFs may be broadly categorized by: 

  • Market capitalization: Also called market cap, this may be broken down into the three main capitalization categories: large cap, mid cap and small cap. 
  • Growth: These ETFs will primarily track an index of company stock that has potential to grow faster than the broader market. 
  • Income: These ETFs will primarily track an index of stocks issued by companies that pay dividends, which can be used by an investor as a source of income. 
  • Geography: This may be further defined by country, such as the U.S., or region, such as North America. ETFs can also be categorized by developed markets, which include countries and regions, such as the U.S., Europe and Japan, or emerging markets, such as China, Brazil and India.  
  • Sector: Also referred to as niche or focus, this refers to ETFs that focus only on a particular sector, such as technology or health, or a narrower niche, such as blockchain or pharmaceuticals.

Tip: For a complete breakdown, see our article, What Are the Different Types of ETFs?

Choose the Best ETFs For You 

To choose the right ETFs for a portfolio, an investor will begin with their personal investment objective, which may be defined by their time horizon and tolerance for risk. However, there are some best practices to follow for ETF selection criteria, which may include key data points, such as expense ratios, assets under management and other factors.  

Factors to consider when choosing ETFs include: 

  • Expense ratio: Since most ETFs passively track a benchmark index, low expenses can translate to higher returns in the long term. For this reason, a lower expense ratio is generally advantageous for an ETF. 
  • Assets under management: When an ETF has high AUM, it will typically have higher trading volume and greater liquidity compared with ETFs with low AUM.  
  • Dividend yield: For income investors, ETFs that pay higher dividends may be attractive. However, investors should keep in mind that high yields do not always indicate high quality. 
  • Time since inception: An ETF with a long track record, such as five years or more, provides a longer time frame to analyze historical returns, whereas a new ETF may not provide sufficient history to review performance. 
  • Tracking error: Not all ETFs closely track the performance of their respective benchmarks. In theory, an ETF’s returns should track the benchmark performance less the fund’s fees.

Tip: For a list of specific ETF examples, see our article, Best ETFs for Beginners: The Complete Guide.

Bottom Line on ETFs for Young Investors

Finding the best ETFs for young investors is a process like any other kind that an investor may follow. The ETF selection process depends largely on an individual investor’s personal goals and objectives, such as their time horizon for investing and their tolerance for risk.  

To find ETFs that are right for your portfolio, be sure to check out our ETF finder, which helps to screen over 3,000 ETFs and narrow down to the funds that work best for your goals. Investors may also look at a list of ETFs to see top funds in each style or category. 

Kent Thune is Research Lead for etf.com, focusing on educational content, thought leadership, content management and search engine optimization. Before joining etf.com, he wrote for numerous investment websites, including Seeking Alpha and Kiplinger. 

 

Kent holds a Master of Business Administration (MBA) degree and is a practicing Certified Financial Planner (CFP®) with 25 years of experience managing investments, guiding clients through some of the worst economic and market environments in U.S. history. He has also served as an adjunct professor, teaching classes for The College of Charleston and Trident Technical College on the topics of retirement planning, business finance, and entrepreneurship. 

 

Kent founded a registered investment advisory firm in 2006 and is based in Hilton Head Island, SC, where he lives with his wife and two sons. Outside of work, Kent enjoys spending time with his family, playing guitar, and working on his philosophy book, which he plans to publish in the coming year.