What Is an ETF? Fund (ETF) Definition
What Is an ETF? Fund (ETF) Definition
Exchange-Traded Fund (ETF) Definition
What Is an ETF?
An exchange-traded fund, or ETF, is a bundle of securities that investors can buy or sell on a stock exchange. An ETF can include anywhere from a handful to thousands of stocks, bonds, commodities or other assets. Like stocks, the prices of ETFs fluctuate daily based on the market value of their holdings.
Investors use ETFs to gain diversification or invest in certain market sectors or themes, like an energy ETF or an S&P 500 index fund. Some ETFs also provide retail investors access to securities that they might otherwise not be able to access. In recent decades, ETFs have become extremely popular investments. As of June 2021, the global ETF market was worth $9.35 trillion.
How Do ETFs Work?
Investors can buy or sell ETFs on an exchange any time the exchange is open, just like they buy or sell shares of stock. Like a stock, an ETF has a ticker symbol, and investors can easily obtain an ETF quote through their online brokerage or trading app.
One difference between an ETF and a stock is that the total number of shares of an ETF can fluctuate daily due to the creation of new shares and redemption of existing shares. Fund managers often adjust the total number of shares of an ETF to keep the price of the ETF in line with the collective value of the underlying securities it holds.
An ETF sponsor is an entity that decides to make an ETF, but the sponsor must work with an authorized participant, or AP, to actually create ETF shares. An AP is a large financial institution that purchases the underlying securities the ETF holds and then exchanges them for a large block of ETF shares of equal value. This block is called a “creation unit,” and it typically ranges between 25,000 and 200,000 shares.
Types of ETFs
Several types of ETFs serve different purposes and appeal to investors for a variety of reasons. Index ETFs are designed to track a particular market index, such as the S&P 500. Bond ETFs are designed to provide exposure to a variety of bonds, including U.S. Treasurys, municipal bonds, and investment-grade and high-yield corporate bonds. Sector and industry ETFs provide pure exposure to a particular market sector, such as technology or financials, or a particular industry, such as semiconductors or insurance. Inverse ETFs are a special type of ETF that is structured to increase in value as the price of its underlying market or index decreases in value. Leveraged ETFs are designed to amplify the returns of an underlying asset or index, typically by a multiple of two or three.
Benchmarks
ETFs are usually designed to track a certain benchmark or index representing a particular subset of the global financial market. The SPDR S&P 500 ETF Trust (ticker: SPY) and other large-cap U.S. equity ETFs use the S&P 500 index as their benchmark. The Vanguard Total Stock Market ETF (VTI) uses the CRSP US Total Market Index as its benchmark. The Nasdaq-100 and the Nasdaq Composite are two more popular benchmarks for ETFs aiming for a heavier weighting of technology stocks.
Popular ETFs
Three of the four largest ETFs by total assets all track the S&P 500:
What Is an ETF?
An exchange-traded fund, or ETF, is a bundle of securities that investors can buy or sell on a stock exchange. An ETF can include anywhere from a handful to thousands of stocks, bonds, commodities or other assets. Like stocks, the prices of ETFs fluctuate daily based on the market value of their holdings.
Investors use ETFs to gain diversification or invest in certain market sectors or themes, like an energy ETF or an S&P 500 index fund. Some ETFs also provide retail investors access to securities that they might otherwise not be able to access. In recent decades, ETFs have become extremely popular investments. As of June 2021, the global ETF market was worth $9.35 trillion.
How Do ETFs Work?
Investors can buy or sell ETFs on an exchange any time the exchange is open, just like they buy or sell shares of stock. Like a stock, an ETF has a ticker symbol, and investors can easily obtain an ETF quote through their online brokerage or trading app.
One difference between an ETF and a stock is that the total number of shares of an ETF can fluctuate daily due to the creation of new shares and redemption of existing shares. Fund managers often adjust the total number of shares of an ETF to keep the price of the ETF in line with the collective value of the underlying securities it holds.
An ETF sponsor is an entity that decides to make an ETF, but the sponsor must work with an authorized participant, or AP, to actually create ETF shares. An AP is a large financial institution that purchases the underlying securities the ETF holds and then exchanges them for a large block of ETF shares of equal value. This block is called a “creation unit,” and it typically ranges between 25,000 and 200,000 shares.
Types of ETFs
Several types of ETFs serve different purposes and appeal to investors for a variety of reasons. Index ETFs are designed to track a particular market index, such as the S&P 500. Bond ETFs are designed to provide exposure to a variety of bonds, including U.S. Treasurys, municipal bonds, and investment-grade and high-yield corporate bonds. Sector and industry ETFs provide pure exposure to a particular market sector, such as technology or financials, or a particular industry, such as semiconductors or insurance. Inverse ETFs are a special type of ETF that is structured to increase in value as the price of its underlying market or index decreases in value. Leveraged ETFs are designed to amplify the returns of an underlying asset or index, typically by a multiple of two or three.
Benchmarks
ETFs are usually designed to track a certain benchmark or index representing a particular subset of the global financial market. The SPDR S&P 500 ETF Trust (ticker: SPY) and other large-cap U.S. equity ETFs use the S&P 500 index as their benchmark. The Vanguard Total Stock Market ETF (VTI) uses the CRSP US Total Market Index as its benchmark. The Nasdaq-100 and the Nasdaq Composite are two more popular benchmarks for ETFs aiming for a heavier weighting of technology stocks.
Popular ETFs
Three of the four largest ETFs by total assets all track the S&P 500:
- SPDR S&P 500 ETF Trust.
- iShares Core S&P 500 ETF (IVV).
- Vanguard S&P 500 ETF (VOO).
Re: What Is an ETF? Fund (ETF) Definition
ETF Metrics
There are several common metrics that investors use to analyze an ETF. Assets under management, or AUM, is the total market value of all of an ETF’s holdings. Net asset value, or NAV, is calculated by summing up the total value of all the fund’s assets, subtracting its liabilities and then dividing by the number of outstanding shares. The prices of most ETFs are roughly in line with their NAVs, but investors should note any ETFs trading at significant premiums or discounts to NAV. The expense ratio is the percentage of an investor’s ETF holdings that will be deducted annually as a fee paid to the company managing the fund. Expense ratios vary widely from fund to fund and are an important factor for any investor considering an ETF.
Why You Need to Know About ETFs
ETFs are a great way for even casual investors to gain market diversification without having a large amount of money to invest. ETFs are also an excellent way to establish a diversified position in a particular investment theme or strategy, such as green energy, cannabis or gold mining. Investing in individual stocks in these types of high-risk industries can expose your portfolio to steep losses if one or more of the individual companies underperform significantly. ETF diversification ensures that investors benefit from the best-performing securities in a benchmark index while being protected from too much exposure to the worst-performing securities.
There are several common metrics that investors use to analyze an ETF. Assets under management, or AUM, is the total market value of all of an ETF’s holdings. Net asset value, or NAV, is calculated by summing up the total value of all the fund’s assets, subtracting its liabilities and then dividing by the number of outstanding shares. The prices of most ETFs are roughly in line with their NAVs, but investors should note any ETFs trading at significant premiums or discounts to NAV. The expense ratio is the percentage of an investor’s ETF holdings that will be deducted annually as a fee paid to the company managing the fund. Expense ratios vary widely from fund to fund and are an important factor for any investor considering an ETF.
Why You Need to Know About ETFs
ETFs are a great way for even casual investors to gain market diversification without having a large amount of money to invest. ETFs are also an excellent way to establish a diversified position in a particular investment theme or strategy, such as green energy, cannabis or gold mining. Investing in individual stocks in these types of high-risk industries can expose your portfolio to steep losses if one or more of the individual companies underperform significantly. ETF diversification ensures that investors benefit from the best-performing securities in a benchmark index while being protected from too much exposure to the worst-performing securities.
Re: What Is an ETF? Fund (ETF) Definition
Pros of ETFs
The most obvious pro of ETF investing is diversification. Investors can gain exposure to anywhere from a handful to thousands of stocks or other securities with one single ETF buy order. ETFs also allow investors with a limited amount of capital to easily diversify their portfolios without buying dozens of different stocks. ETFs provide access to foreign-listed securities, commodities, derivatives and other financial products that are typically only accessible to institutional investors and high-net-worth investors. The diversified nature of ETFs often limits their volatility, as well. While certain ETFs can still be extremely volatile, index ETFs are typically far more stable than the share prices of individual stocks.
Cons of ETFs
ETF investors must pay fees to the companies that manage the fund, and those fees can eat into overall returns. Certain ETFs may have large bid-ask spreads and low liquidity, making it difficult or costly to exit a position quickly. In addition, some ETFs invest in complex securities and use unproven or complicated investment strategies that are risky and difficult to understand. Finally, ETFs are, by design, unlikely to significantly outperform their benchmarks. If you are looking to beat the market, an S&P 500 index ETF is not going to do it.
Creator of ETFs
The first U.S. ETF was designed by a team at the American Stock Exchange led by Nathan Most. At the time, Most presented his idea for an S&P 500 ETF to Vanguard founder Jack Bogle, but Bogle initially rejected the idea. Most then took his ETF idea to State Street, which launched the popular SPDR S&P 500 ETF in 1993.
The most obvious pro of ETF investing is diversification. Investors can gain exposure to anywhere from a handful to thousands of stocks or other securities with one single ETF buy order. ETFs also allow investors with a limited amount of capital to easily diversify their portfolios without buying dozens of different stocks. ETFs provide access to foreign-listed securities, commodities, derivatives and other financial products that are typically only accessible to institutional investors and high-net-worth investors. The diversified nature of ETFs often limits their volatility, as well. While certain ETFs can still be extremely volatile, index ETFs are typically far more stable than the share prices of individual stocks.
Cons of ETFs
ETF investors must pay fees to the companies that manage the fund, and those fees can eat into overall returns. Certain ETFs may have large bid-ask spreads and low liquidity, making it difficult or costly to exit a position quickly. In addition, some ETFs invest in complex securities and use unproven or complicated investment strategies that are risky and difficult to understand. Finally, ETFs are, by design, unlikely to significantly outperform their benchmarks. If you are looking to beat the market, an S&P 500 index ETF is not going to do it.
Creator of ETFs
The first U.S. ETF was designed by a team at the American Stock Exchange led by Nathan Most. At the time, Most presented his idea for an S&P 500 ETF to Vanguard founder Jack Bogle, but Bogle initially rejected the idea. Most then took his ETF idea to State Street, which launched the popular SPDR S&P 500 ETF in 1993.