Exchange-Traded Fund (ETF)

What is an ETF?

An exchange-traded fund (ETF) is a fund that holds a basket of investments, such as stocks or bonds, and trades on a stock exchange as a single share you can buy or sell any time the market is open. Buying one share gives you a small slice of everything the fund holds. Most ETFs track an index, which makes them a popular way to own a whole market in one purchase.

Key takeaways

• An ETF bundles many investments into one share that trades like a stock.
• Its price moves during the trading day, unlike a mutual fund, which is priced once after the close.
• Most ETFs are index funds, and many charge low annual fees.
• You buy ETFs through a brokerage account, an IRA, and sometimes a workplace plan.

How an ETF works

A fund company builds a portfolio, often by copying an index. It then divides ownership into shares that are listed on an exchange. You buy those shares from other investors through your brokerage account, the same way you would buy a single company's stock.

Here is a hypothetical example with round numbers. Say an ETF share costs $100 and the fund holds 1,000 companies. You buy 5 shares for $500. You now own a small piece of all 1,000 companies. If the fund's holdings rise 5% in value, your shares are worth about $525. If they fall 5%, your shares are worth about $475.

Because the price updates all day, you can see what you are paying before you buy. Many brokerages also let you buy fractional shares, so you can invest a set dollar amount, like $50, even if one share costs more.

Every ETF charges an expense ratio, taken out of the fund's value each year. ETFs that track the same index can have different fees and slightly different holdings, so read the fund's summary page before choosing. For an example of comparing two similar funds, see VOO vs VTI.

ETF vs mutual fund

Both pool money from many investors, and both can hold the same investments. The main difference is how they trade. An ETF trades throughout the day at a changing price. A mutual fund is bought and sold once a day at the price set after the market closes, often with a minimum first investment. In a regular brokerage account, ETFs are also often more tax efficient because of how shares are created and redeemed, though the details depend on the fund.

Why it matters for your Money Type

The Strategist Money Type describes someone whose basics are handled: bills are paid, savings exists, and investing has started. The plan works, but it was built for an older version of their income.

For a Strategist, ETFs are building blocks. When a raise comes in, the Strategist First Fix, Save the Raise, says to save the extra before spending catches up. ETFs make it easy to put that new money to work in a brokerage account or Roth IRA in whatever mix fits the plan. The trap is overthinking: owning ten ETFs that hold the same companies adds complexity, not safety.

A Saver can use a single broad ETF as a first investment, once the emergency fund is set. Find your type with the Money Type quiz.

Common questions

Is an ETF a good investment for beginners?

A broad, low-cost index ETF is one of the simplest ways to start investing because one share spreads money across many companies. It still moves with the market, so it fits money you can leave invested for years.

How do ETFs make money?

You can earn from a rising share price and from dividends the fund passes along from the companies it owns. Many brokerages let you reinvest those dividends automatically.

Are ETFs safer than stocks?

A broad ETF is usually less risky than a single stock because one company's bad year is a small part of the whole. It is not risk-free, and an ETF focused on one narrow industry can swing as much as individual stocks.

Do ETFs pay dividends?

Many do. If the companies or bonds in the fund pay dividends or interest, the ETF typically passes that income to shareholders on a regular schedule.