An exchange-traded fund is a basket of securities — stocks, bonds, commodities or some combination of these — that you can buy and sell through a broker. ETFs offer the best attributes of two popular assets: They have the diversification benefits of mutual funds while mimicking the ease with which stocks are traded.
Like any financial product, ETFs aren’t a one-size-fits-all solution. Evaluate them on their own merits, including management costs and commission fees (if any), how easily you can buy or sell them, and their investment quality.
An exchange-traded fund — better known by the acronym “ETF” — is a fund that can be traded on an exchange like a stock (hence the name). ETFs give you a way to buy and sell a basket of assets without having to buy all the components individually.
An ETF works like this: The fund provider owns the underlying assets, designs a fund to track their performance and then sells shares in that fund to investors. Shareholders own a portion of an ETF, but they don’t own the underlying assets in the fund. Even so, investors in an ETF that tracks a stock index get lump dividend payments, or reinvestments, for the stocks that make up the index. (Related: Learn how to invest in index funds.)
How ETFs work, in 3 steps
- An ETF provider considers the universe of assets, including stocks, bonds, commodities or currencies, and creates a basket of them, with a unique ticker.
- Investors can buy a share of that basket, just like buying shares of a company.
- Buyers and sellers trade the ETF throughout the day on an exchange, much like a stock.