The basic idea
An exchange-traded fund, or ETF, is a fund that owns a collection of investments and sells small pieces of that collection to the public. You buy a share of the ETF the same way you buy a share of a company: through a brokerage account, at the current market price, any time the market is open.
Because one share of an ETF is a slice of many holdings, a single purchase can give you exposure to hundreds or thousands of companies. That built-in spreading of risk is the main reason ETFs became popular with everyday investors.
How an ETF works
A fund company designs the ETF around a goal, most often to follow an index. An index is a published list of investments with rules, such as the 500 large US companies in the S&P 500. The ETF buys the holdings in the index so its performance stays close to the index’s performance, before fees.
ETF shares trade on an exchange, so the price moves all day as buyers and sellers agree on a price. Special large institutions help keep that price close to the value of the underlying holdings, which is why a well-run ETF rarely strays far from it.
Kinds of ETFs
ETFs come in many flavors. The most common groups are:
- Broad stock market ETFs that track an index like the S&P 500 or the total US market.
- Sector ETFs that hold one part of the economy, such as technology or energy. See our sector pages.
- Bond ETFs that hold government or corporate bonds.
- Commodity ETFs that track gold, silver or oil.
- International ETFs that hold companies outside the US.
- Actively managed ETFs where a manager chooses holdings instead of following an index. These usually cost more.
What to check before you buy
- Expense ratio. The yearly fee as a percentage of your money. See expense ratios explained.
- Holdings. Read what is actually inside. A fund’s name does not always tell the whole story.
- Size and trading volume. Larger, busier funds tend to have tighter gaps between the buying and selling price.
- Structure. Most ETFs hold the real assets. Some, especially those that use leverage or track futures, behave very differently from the thing they follow. Read the fund’s own documents first.
ETF or index mutual fund?
Both can track the same index. An index mutual fund is priced once a day and is bought directly from the fund company, sometimes with a minimum investment. An ETF trades all day and can often be bought for the price of one share, or less with fractional shares. For long-term investors who buy and hold, the difference is usually small; fees and holdings matter more. See index funds explained.
Quick answers
Is an ETF safe?
An ETF is only as safe as what it holds. A broad stock ETF can lose value when markets fall. A short-term Treasury bond ETF is much steadier. No ETF removes market risk.
Do ETFs pay dividends?
Yes, if the underlying holdings pay them. The fund collects the dividends and usually passes them on to shareholders on a regular schedule.