What Is an Exchange-Traded Fund (ETF)?

An exchange-traded fund (ETF) is a type of pooled investment security that operates much like a mutual fund. 

Typically, ETFs will track a particular index, sector, commodity, or other assets, but unlike mutual funds, ETFs can be purchased or sold on a stock exchange the same way that a regular stock can. An ETF can be structured to track anything from the price of an individual commodity to a large and diverse collection of securities. ETFs can even be structured to track specific investment strategies.

The first ETF was the SPDR S&P 500 ETF (SPY), which tracks the S&P 500 Index, and which remains an actively traded ETF today.

KEY TAKEAWAYS

• An exchange-traded fund (ETF) is a basket of securities that trades on an exchange just like a stock does.
• ETF share prices fluctuate all day as the ETF is bought and sold; this is different from mutual funds, which only trade once a day after the market closes.2
• ETFs can contain all types of investments, including stocks, commodities, or bonds; some offer U.S.-only holdings, while others are international.
• ETFs offer low expense ratios and fewer broker commissions than buying the stocks individually.

Understanding Exchange-Traded Funds (ETFs)

An ETF is called an exchange-traded fund because it’s traded on an exchange, just like stocks. The price of an ETF’s shares will change throughout the trading day as the shares are bought and sold on the market. This is unlike mutual funds, which are not traded on an exchange and trade only once per day after the markets close. Additionally, ETFs tend to be more cost-effective and more liquid compared to mutual funds.

An ETF is a type of fund that holds multiple underlying assets, rather than only one, like a stock does. Because there are multiple assets within an ETF, it can be a popular choice for diversification. ETFs can thus contain many types of investments, including stocks, commodities, bonds, or a mixture of investment types.

An ETF can own hundreds or thousands of stocks across various industries, or it could be isolated to one particular industry or sector. Some funds focus on only U.S. offerings, while others have a global outlook. For example, banking-focused ETFs would contain stocks of various banks across the industry.

An ETF is a marketable security, meaning it has a share price that allows it to be easily bought and sold on exchanges throughout the day, and it can be sold short. In the United States, most ETFs are set up as open-ended funds and are subject to the Investment Company Act of 1940, except where subsequent rules have modified their regulatory requirements. Open-end funds do not limit the number of investors involved in the product.

Key Features of ETFs:

• Diversification: ETFs hold a variety of assets, which can help reduce risk compared to investing in individual securities. 
• Tradability: ETFs are bought and sold on exchanges, just like stocks, allowing for real-time pricing and trading throughout the day. 
• Transparency: Many ETFs track a specific index, making it easy to understand what the fund is invested in. 
• Cost-Effectiveness: ETFs generally have lower expense ratios (fees) compared to actively managed mutual funds. 
• Accessibility: ETFs offer a convenient way for investors to gain exposure to a wide range of asset classes, sectors, or investment strategies. 

How ETFs Work:

1. Fund Creation: An ETF is created when a financial institution (like a brokerage or investment company) purchases a basket of securities that match the fund’s objective. 
2. Listing on Exchange: The fund is then listed on an exchange, where investors can buy and sell shares. 
3. Trading: Investors can buy and sell ETF shares on the exchange, just like they would with individual stocks. 
4. Management: The fund manager is responsible for managing the ETF’s holdings, ensuring they align with the fund’s investment strategy. 
5. Types of ETFs:
   • Index ETFs: These ETFs track a specific market index, like the S&P 500. 
   • Actively Managed ETFs: These ETFs are managed by professionals who aim to outperform a specific benchmark. 
   • Fixed-Income ETFs: These ETFs invest in bonds. 
6. Sector and Industry ETFs: These ETFs focus on specific sectors or industries, like technology or healthcare. 
7. Commodity ETFs: These ETFs track the price of commodities, like gold or oil. 
8. Foreign Market ETFs: These ETFs provide exposure to international markets. 
9. In essence, ETFs offer a convenient and cost-effective way for investors to gain diversified exposure to various markets and investment strategies.