ETF (Exchange-Traded Fund)
Definition
A pooled investment fund that trades on stock exchanges like a regular stock, typically tracking an index, sector, or asset class with lower fees than actively managed mutual funds.
An Exchange-Traded Fund bundles multiple securities into a single investable product that you buy and sell on a stock exchange. The most popular ETF in the world, SPY, tracks the S&P 500 index, giving investors exposure to 500 large US companies in a single trade.
ETFs combine the diversification benefits of mutual funds with the trading flexibility of stocks. You can buy and sell ETFs throughout the trading day at market prices, use limit orders, and even short sell them — none of which is possible with traditional mutual funds that price once daily after market close.
The expense ratio is a key advantage of ETFs. Index-tracking ETFs often charge 0.03% to 0.20% annually, compared to 0.50% to 1.50% for actively managed mutual funds. Over decades of compounding, this fee difference can cost tens of thousands of dollars on a large portfolio.
ETFs exist for virtually every investment category: US stocks, international stocks, bonds, commodities, real estate (REITs), sectors (technology, healthcare), factors (value, momentum), and even crypto. This breadth makes ETFs the building blocks of modern portfolio construction.
Tax efficiency is another ETF advantage. Their unique creation/redemption mechanism means most ETFs rarely distribute capital gains to shareholders, unlike mutual funds that can pass through taxable gains even to investors who didn't sell. This makes ETFs particularly efficient in taxable accounts.
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Frequently Asked Questions
What's the difference between an ETF and an index fund?
An index fund is a type of mutual fund that tracks an index. An ETF can also track an index but trades like a stock. Many index funds have corresponding ETFs (like Vanguard's VFIAX mutual fund and VOO ETF, both tracking the S&P 500). ETFs offer intraday trading and better tax efficiency.
How many ETFs should I own?
A simple, effective portfolio can be built with just 2-3 ETFs: a total US stock market ETF, a total international ETF, and a total bond market ETF. More ETFs don't necessarily mean better diversification — overlapping holdings can create unintended concentration.