Background
An exchange-traded fund, or ETF, is a type of investment fund that can be bought and sold on a stock exchange.
While there are different varieties of ETFs, they all allow investors to invest in a “basket” of different assets. Depending on the type, the basket may contain securities like stocks, commodities like gold and silver, or another class of assets.
Exchange-traded funds are popular investment vehicles for both retail investors (1440 Topics: Retail Investors) and institutional investors. As of 2024, there were over 3,000 listed in the US, and the global ETF market was worth more than $10T.
These funds make it easier for the average person to diversify their portfolio while lowering risk in comparison to investing in an individual security. As of last year, more than 45% of retail investors chose to invest in ETFs due to these and other perks, such as their tax advantages.
How Investing in ETFs Works
Rather than buying and selling individual stocks or other assets, like a share of Microsoft or an individual bitcoin, exchange-traded funds track an underlying index, industry, or thematic group. So when an investor buys a share of one, they gain exposure to multiple investments. The performance of that underlying “basket” of investments dictates the fund’s performance.
For instance, a popular exchange-traded fund is the SPDR S&P 500 ETF, which tracks the benchmark S&P 500 index, so its investors gain exposure to all 500 companies in the index. When the S&P 500 is up, so is the fund itself. (See a list of popular ETFs here.)
Other varieties offer exposure to different asset classes like cryptocurrency and commodities. The iShares Bitcoin Trust, for instance, is an exchange-traded fund that holds bitcoin instead of stocks, whereas the Teucrium Wheat Fund holds wheat futures contracts.
The above categories are far from the only types of exchange-traded funds available in the market—learn more about these and other types here.
Investors can purchase shares in ETFs through their regular brokerage or retirement account, as these funds trade on the same exchanges as stocks (think: the Nasdaq and the New York Stock Exchange).
Some also pay out dividends quarterly or monthly. Investors can choose to receive cash payments or reinvest the dividends to purchase more shares. (See a roundup of monthly dividend-paying ETFs here.)
Why ETFs?
Exchange-traded funds can help diversify portfolios, making it easier to benefit from price gains in different holdings. Plus, they’re easily accessible through stock exchanges, and they tend to be transparent about their holdings.
For instance, buying an individual biotech or pharmaceutical stock can be risky, as its performance can depend on factors such as clinical trials and regulatory approvals, so some investors buy a biotech ETF like the SPDR S&P Biotech ETF instead. That way, if one company’s stock in the fund performs poorly, it’s cushioned by outperformers.
In the case of nonstock exchange-traded funds, investors may find purchasing shares of a fund easier than investing in the underlying asset itself. A bitcoin ETF, for instance, allows someone to gain exposure to bitcoin’s price movements without having to create a crypto wallet or potentially use a less familiar exchange or trading platform.
Whether they passively follow an index like the S&P 500 or are actively managed by an adviser, ETFs disclose their holdings. For example, Cathie Wood, a famous ETF manager, updates investors on her funds’ holdings at the end of each trading day.
Considerations Before Purchasing
Some ETFs have management fees or “expense ratios” associated with investing (learn more here). Fund issuers often maintain webpages for each of their exchange-traded funds that include these key stats.
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