An exchange-traded fund (ETF) is a basket of investments, such as stocks or bonds, that trades on a stock exchange like a single share. Buying one share of an ETF gives you a small piece of everything the fund holds.
How ETFs work
A fund company creates the ETF and decides what it will hold, often by following an index such as the S&P 500. The ETF's shares then trade on an exchange throughout the day. Large financial firms can create or redeem ETF shares in big blocks, which keeps the ETF's market price very close to the value of the holdings inside it.
Main types of ETFs
- Broad market index ETFs: track the S&P 500, the total US market or global stocks. The most common core holding for long-term investors.
- Sector ETFs: focus on one industry such as technology, health care or energy.
- Bond ETFs: hold government or corporate bonds for income and stability.
- Dividend ETFs: hold companies selected for their dividends. See dividend investing for beginners.
- International ETFs: hold stocks from developed or emerging markets.
- Thematic and active ETFs: follow a theme or a manager's picks rather than a broad index; usually more expensive.
- Leveraged and inverse ETFs: aim to multiply or reverse an index's daily move. They're built for short-term trading and can behave very differently from what you'd expect over longer periods.
Why investors like ETFs
- Instant diversification in a single purchase. See how to diversify your portfolio.
- Low costs: broad index ETFs often charge very small annual fees.
- Flexibility: trade any time the market is open, with the same order types as stocks.
- Tax efficiency in taxable accounts compared with many mutual funds. See ETFs vs. mutual funds.
What to check before buying
- Expense ratio: the annual fee. Lower is better when two funds track the same thing.
- What it holds: the index it tracks and its top holdings. Watch for overlap with funds you already own.
- Size and trading volume: larger, heavily traded ETFs usually have tighter bid-ask spreads, so you lose less when buying and selling.
- Tracking: how closely the fund has matched its index over time.
Risks
An ETF is only as safe as what it holds. A stock ETF will fall when the stock market falls, and a narrow sector or thematic ETF can fall much further. Know what you own and why.
You can look up popular ETFs such as SPY, VOO, VTI and QQQ on StockEngine to see price charts and performance, and add them to your portfolio tracker to compare them with individual stocks.
This article is educational and not investment advice.
Frequently asked questions
Are ETFs safe for beginners?
Broad, low-cost index ETFs are a common starting point for beginners because they're diversified. They still rise and fall with the markets they track, and narrow or leveraged ETFs carry much more risk.
How do ETFs make money for investors?
Through the rising value of the holdings inside the fund and any dividends or interest those holdings pay, which the ETF passes on to shareholders.
What is an ETF expense ratio?
The annual fee the fund charges, shown as a percentage of your investment. A 0.05% expense ratio costs $5 a year for every $10,000 invested.
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