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Exchange-Traded Funds

Exchange-Traded Funds

A basket of assets that tracks an index, a commodity, or bonds, that can be traded like common stock on a stock exchange.

An Exchange-Traded Fund, or ETF, is a security traded on markets that can be thought of as a basket of other assets. ETFs price fluctuate throughout the day as they are bought and sold. ETFs often track a specific index, which allows consumers to invest directly in an entire industry or market, with just a small amount of money.

In this way, ETFs are similar to mutual funds. Retail investors generally want to invest to a wide range of things, both to reduce risk and to gain more exposure, but only have a small amount of money. As a result, they instead buy a small share of a large entity that, in turn, owns shares of a basket of individual securities, such as stock. The key differences between ETFs and mutual funds is that ETFs are generally much more liquid, as they can be bought and sold on a exchange throughout the day. ETFs also offer investors much more transparency, and the contents of the ETF basket are public at all times. These are some of the reasons ETFs have widely gained popularity, relative to mutual funds, in recent years.

As an example, the SPY ETF is the most popular ETF, that can be bought and sold in the stock market. It is issued by SPDR, and tracks the S&P 500. That is, the basket contains all the companies in the S&P 500, in the correct quantities as to match the movements of the index. This has an advantage because most people don't have the money, nor the time, to go and buy the individual stocks of all 500 companies. Instead, the same exposure can be obtained by just owning the ETF. Buying a share of SPY is equivalent to buying a small fraction of each of the underlying company stocks. In units of 50,000 shares, anyone can redeem the ETF for the underlying shares, for a fee. Similarly, one can take the individual stocks in the correct quantities and create an ETF. Other common ETFs are QQQ (tracks NASDAQ), XLF (Financial Sector), and EEM (Emerging Markets). As with SPY, buying a share of each of these gives you ownership of a large array individual stocks.

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