ETFs for Beginners: What They Are, How They Work, Types, Fees & How to Invest
Exchange-traded funds can give investors a convenient way to own a basket of investments through a single fund. Learn what ETFs are, how they work, the different types, how ETF prices and NAV work, the fees and risks to understand, and how beginners can evaluate an ETF before investing.
InvestingWhat you'll learn
- What an ETF is and how it works
- How ETFs differ from individual stocks
- Index ETFs vs. actively managed ETFs
- Stock, bond, sector, commodity and other ETF types
- NAV, market price, premiums and discounts
- ETF fees, expense ratios and trading costs
- Bid-ask spreads and liquidity
- ETF risks and common mistakes
- How beginners can choose and buy ETFs
Table of Contents
- What Is an ETF?
- How Do ETFs Work?
- Why Do Investors Use ETFs?
- Types of ETFs
- Stock ETFs
- Bond ETFs
- Sector and Industry ETFs
- International ETFs
- Commodity and Alternative ETFs
- Index ETFs vs. Active ETFs
- ETF Diversification
- ETF NAV vs. Market Price
- Premiums and Discounts
- Bid-Ask Spreads and Liquidity
- ETF Fees and Expenses
- How ETFs Make Money
- ETF Risks
- Leveraged and Inverse ETFs
- ETFs vs. Individual Stocks
- ETFs vs. Mutual Funds
- How to Invest in ETFs
- How to Choose an ETF
- Common ETF Mistakes
- ETF Scams and Red Flags
- Beginner ETF Checklist
- Frequently Asked Questions
What Is an ETF?
ETF stands for exchange-traded fund.
An ETF is a pooled investment product that collects money from investors and uses that money to hold a portfolio of investments according to the fund's stated objective.
Depending on the ETF, that portfolio might contain stocks, bonds, commodities, cash-related instruments, or other eligible investments.
Instead of buying every investment inside the portfolio individually, an investor can buy shares of the ETF. Each share represents an interest in the fund's portfolio.
The word "exchange-traded" is important.
Unlike a traditional mutual fund, ETF shares are generally bought and sold by retail investors on a securities exchange during the trading day, at market prices.
One ETF
You purchase shares of one investment product.
Underlying Portfolio
The ETF may own many individual securities or other investments.
This structure is one reason ETFs have become popular among investors. A single ETF can potentially provide exposure to a large group of securities, although the actual level of diversification depends entirely on what the ETF owns.
How Do ETFs Work?
To understand ETFs, it helps to separate the fund itself from the shares that individual investors trade.
The ETF creates a portfolio
An ETF is established with a particular investment objective. The fund then holds a portfolio designed to pursue that objective.
For example, an ETF may seek to track a broad stock-market index. Another may invest in government bonds. Another may focus on companies in a specific industry.
Investors buy ETF shares
Retail investors generally buy and sell ETF shares through a brokerage account or another investment platform that provides access to the relevant market.
The investor does not normally buy each underlying security separately. Instead, the investor buys shares representing an interest in the ETF.
ETF shares trade throughout the day
ETF shares generally trade on an exchange during market hours. Their market price changes as buyers and sellers place orders.
This is different from the typical mutual-fund structure, where investors transact at the fund's next calculated net asset value.
Authorized participants help the ETF structure operate
Behind the scenes, large financial institutions known as authorized participants can create and redeem large blocks of ETF shares with the fund.
This creation-and-redemption mechanism is one of the important structural features that helps ETFs operate and can help keep an ETF's market price relatively close to the value of its underlying portfolio.
Individual investors generally do not participate directly in these creation units. They buy and sell ETF shares in the market.
Investors contribute money → the ETF holds a portfolio → ETF shares represent interests in that portfolio → investors trade those shares in the market.
Why Do Investors Use ETFs?
ETFs can serve several different purposes in an investment portfolio. The exact benefits depend on the ETF you choose.
1. Diversification
A broad ETF can give an investor exposure to many companies or securities through one investment.
Diversification can reduce the impact that one company or security has on the entire portfolio.
2. Convenience
Buying one ETF can be simpler than researching and purchasing dozens or hundreds of individual securities.
3. Market access
ETFs can give investors access to particular markets, asset classes, industries, countries or investment strategies.
4. Potentially lower costs
Some ETFs have relatively low operating expenses, especially broad index-tracking funds.
But low fees should never be assumed. Investors need to examine the actual expense ratio and other trading costs.
5. Trading flexibility
Because ETF shares trade on exchanges, investors can generally buy or sell them during the trading day at available market prices.
6. Transparency
Many ETFs disclose their portfolio holdings frequently, although the exact disclosure requirements and structure depend on the type and jurisdiction of the fund.
Types of ETFs
ETFs come in many forms. The most important thing is to understand the asset or strategy the ETF is designed to provide.
Stock ETFs
Hold portfolios of stocks and may track broad markets, countries, regions, sectors or particular strategies.
Bond ETFs
Hold portfolios of bonds and can focus on government, corporate, municipal, international or other fixed-income securities.
Sector ETFs
Focus on companies operating within a particular economic sector or industry.
International ETFs
Provide exposure to companies or securities outside an investor's home country.
Commodity ETFs
Seek exposure to commodities or commodity-related investments. Their structures can differ substantially, so investors should understand what actually backs the product.
Strategy ETFs
Follow particular investment approaches such as dividend, value, growth, minimum volatility or other strategies.
Stock ETFs
Stock ETFs invest primarily in equities.
Some track broad market indexes and may hold hundreds or thousands of companies. Others concentrate on a country, region, sector, company size or investment strategy.
Broad-market stock ETFs
Broad-market ETFs are designed to give exposure to a wide group of companies. They can be useful for investors who want diversification without selecting individual stocks.
Large-company ETFs
Some ETFs focus primarily on larger companies. These funds may behave differently from funds focused on smaller companies.
Small-company ETFs
Small-company ETFs concentrate on smaller businesses and can have different risk and return characteristics from large-company funds.
Investors should avoid assuming that "more companies" automatically means "lower risk." The companies can still be concentrated in one country, sector or economic theme.
Bond ETFs
Bond ETFs hold portfolios of bonds.
They can focus on government debt, corporate bonds, high-yield bonds, short-term bonds, long-term bonds, international bonds or other fixed-income categories.
Why use a bond ETF?
A bond ETF can provide diversified exposure to many bonds through one exchange-traded investment.
This may be convenient for investors who do not want to research and purchase individual bonds.
Bond ETF risks
Bond ETFs are not guaranteed. Their prices can change because of interest rates, credit conditions, maturity, duration, liquidity, inflation and other factors.
A bond ETF also generally does not have one maturity date at which the investor's shares simply return to a fixed face value.
Sector and Industry ETFs
Sector ETFs concentrate on companies operating in a particular area of the economy.
Examples can include technology, financial services, healthcare, energy, industrial companies, consumer businesses and other sectors.
Sector ETFs can be useful when an investor intentionally wants targeted exposure.
However, concentration is also the main risk.
If the sector experiences weak demand, regulatory pressure, technological disruption or other problems, the ETF can fall substantially even if the broader market performs better.
International ETFs
International ETFs give investors exposure to securities outside their home market.
They can focus on a single country, a region or a broad group of international markets.
Why invest internationally?
- To diversify geographically
- To access businesses unavailable in the home market
- To gain exposure to different economies
- To reduce dependence on one country's market
International ETF risks
International investing can introduce additional risks, including currency movements, political conditions, different accounting rules, regulatory differences, market liquidity and economic instability.
Currency risk can be particularly important. Even if the underlying investments rise in their local currency, an unfavorable exchange-rate movement can reduce the return when measured in the investor's home currency.
Commodity and Alternative ETFs
Some exchange-traded products provide exposure to commodities or other alternative assets.
However, the word "ETF" should not be treated as a guarantee that every exchange-traded product has the same legal structure.
Some exchange-traded products may be structured as funds, trusts, notes or other vehicles. The underlying exposure, legal structure and risks can therefore differ significantly.
What should you check?
- What asset actually creates the exposure?
- Does the product own the asset directly?
- Does it use futures or derivatives?
- Is there counterparty risk?
- How does the product track its benchmark?
- What fees and trading costs apply?
- What happens during extreme market conditions?
Index ETFs vs. Actively Managed ETFs
One of the most important differences between ETFs is whether the fund follows an index or uses an active investment strategy.
What is an index ETF?
An index ETF is designed to track the performance of a specified index or benchmark, before fees and subject to tracking differences.
The fund does not generally try to select investments in order to outperform the index. Instead, it seeks to achieve a return that closely corresponds to the target index.
What is an actively managed ETF?
An actively managed ETF has a manager or management team making investment decisions according to the fund's stated objective.
The manager can generally buy or sell securities without being required to replicate a particular index.
Which is better?
There is no universal answer.
Index ETFs often emphasize broad exposure, rules-based investing and relatively low costs. Active ETFs may offer more flexibility in security selection but can have higher costs and manager-specific risks.
| Feature | Index ETF | Active ETF |
|---|---|---|
| Objective | Track a specified index or benchmark. | Use active decisions to pursue the fund's objective. |
| Portfolio decisions | Generally rules-based. | Generally manager-driven. |
| Trading | Often relatively limited compared with active strategies. | May trade more frequently. |
| Fees | Often relatively low, but varies. | Can be higher, but varies. |
| Main consideration | How well it tracks its benchmark and what it costs. | Strategy, manager, costs and ability to execute the strategy. |
How Diversified Are ETFs?
One of the biggest advantages of ETFs can be diversification.
But diversification is not automatic.
Consider two hypothetical ETFs.
ETF A owns hundreds of companies across many industries and countries.
ETF B owns 25 companies from one narrow industry.
Both are ETFs, but their diversification is very different.
Look beyond the number of holdings
The number of holdings is only one part of diversification.
You should also examine:
- Largest holdings
- Industry concentration
- Geographic concentration
- Company size
- Asset class
- Currency exposure
- Strategy
A fund may own hundreds of companies while still being heavily influenced by a small group of very large companies.
Bid-Ask Spreads and ETF Liquidity
ETFs trade like securities, which means investors encounter a bid price and an ask price.
What is the bid?
The bid is the highest price a buyer is currently willing to pay.
What is the ask?
The ask is the lowest price at which a seller is currently willing to sell.
What is the spread?
The bid-ask spread is the difference between the bid and ask.
A narrower spread generally means lower trading friction. A wider spread can increase the cost of entering or exiting an investment.
Why does liquidity matter?
Highly traded ETFs often have more active markets and can have tighter spreads, although liquidity should not be judged only by the ETF's trading volume.
The liquidity of the ETF's underlying securities can also matter.
ETF Fees and Expenses
Every investment product has costs, and ETFs are no exception.
Fees matter because money paid in expenses is money that does not remain invested and earning returns for you.
Expense ratio
The expense ratio represents the fund's annual operating expenses as a percentage of assets.
For example, an expense ratio of 0.20% means that the annual operating expenses are equivalent to approximately 0.20% of assets, although investors do not generally receive a separate bill for that amount. The expenses are reflected in the fund's NAV.
Trading commissions
Depending on the brokerage platform and jurisdiction, buying or selling an ETF may involve commissions or other transaction charges.
Bid-ask spread
The difference between the price at which you can buy and the price at which you can sell can represent another trading cost.
Premiums and discounts
If an ETF trades above or below NAV, the difference can affect the price you pay or receive.
Why small fees matter
A seemingly small difference in annual costs can compound over many years.
This does not mean that the cheapest ETF is always the best ETF. A slightly more expensive fund may provide a different strategy, better implementation, greater diversification or another feature that matters to an investor.
The goal is to compare the total cost and value, not simply chase the lowest advertised number.
How Do ETFs Make Money?
The way an ETF produces returns depends on what it owns.
Stock ETF returns
A stock ETF may generate returns through increases in the prices of the stocks it owns and through dividends or other distributions from those companies.
Bond ETF returns
A bond ETF can receive interest from its underlying bonds. The market prices of those bonds can also rise or fall.
Commodity-related ETF returns
Returns can depend on the structure of the product and the way it obtains exposure to the commodity or related instruments.
Capital appreciation
If the value of the underlying portfolio increases, the ETF's NAV may increase, and its market price may also rise.
Distributions
Some ETFs distribute income or capital gains to shareholders.
Investors should not judge an ETF solely by its distribution yield. A high distribution can come from different sources and does not necessarily represent a high-quality or low-risk investment.
ETF Risks You Need to Understand
ETFs are convenient investment vehicles, but the ETF structure does not eliminate investment risk.
1. Market risk
If the securities held by an ETF decline in value, the ETF can also decline.
2. Concentration risk
An ETF focused on one sector, country, theme or small group of securities can be much less diversified than its name may suggest.
3. Tracking risk
An index ETF may not perfectly match the return of its target index. Fees, transaction costs, portfolio sampling, market conditions and other factors can create differences.
4. Liquidity risk
Some ETFs may have lower trading activity or hold less-liquid underlying investments. This can make buying or selling more difficult or expensive.
5. Premium/discount risk
ETF shares can trade above or below NAV.
6. Currency risk
International ETFs can expose investors to exchange-rate movements.
7. Interest-rate risk
Bond ETFs can be affected by changing interest rates. Longer-duration bond ETFs can generally be more sensitive to rate changes.
8. Credit risk
Bond ETFs can be exposed to the creditworthiness of their underlying issuers.
9. Manager risk
Actively managed ETFs depend partly on the investment decisions and implementation of their managers.
10. Product-structure risk
Some complex exchange-traded products use derivatives, leverage, inverse strategies or other structures that can behave very differently from a traditional broad-market ETF.
Leveraged and Inverse ETFs
Some ETFs are designed to produce amplified or opposite daily movements relative to a benchmark.
Leveraged ETFs
A leveraged ETF may seek to provide a multiple of the daily performance of an underlying index or benchmark.
For example, a product might target twice the daily movement of a benchmark.
Inverse ETFs
An inverse ETF seeks to move in the opposite direction of a benchmark over its stated measurement period, often on a daily basis.
Why are they different?
Daily resetting can cause the long-term performance of leveraged or inverse ETFs to differ significantly from simply multiplying or reversing the benchmark's total return over a longer period.
This can become particularly important when the underlying market is volatile.
ETFs vs. Individual Stocks
Buying an individual stock means your investment is directly tied to one company's performance.
Buying a broad stock ETF can give you exposure to many companies at once.
| Feature | ETF | Individual Stock |
|---|---|---|
| Number of investments | Can contain many securities. | Usually represents one company. |
| Diversification | Can provide substantial diversification. | Much more concentrated. |
| Company-specific risk | Can be spread across many companies. | High exposure to one company. |
| Fees | Usually has fund expenses. | No fund expense ratio, but trading costs may apply. |
| Research | Requires understanding the fund and its strategy. | Requires deeper research into the company. |
Neither approach is automatically better. Some investors use broad ETFs as the foundation of a portfolio and individual stocks for more targeted positions. Others prefer a portfolio made almost entirely of diversified funds.
ETFs vs. Mutual Funds
ETFs and mutual funds have many similarities. Both can pool investor money into portfolios of stocks, bonds and other investments.
However, their trading structures differ.
| Feature | ETF | Mutual Fund |
|---|---|---|
| Trading | Generally trades on an exchange throughout the trading day. | Typically bought or redeemed at the next calculated NAV. |
| Market price | Can trade above or below NAV. | Transactions are generally based on NAV. |
| Intraday trading | Yes, where an exchange market exists. | Generally no intraday market-price trading. |
| Investment strategies | Can be passive or active. | Can be passive or active. |
| Fees | Fund expenses plus possible trading costs. | Fund expenses plus possible shareholder or transaction costs. |
The important lesson is not that ETFs are automatically better than mutual funds. Instead, compare the specific fund's strategy, diversification, costs, tax considerations, liquidity and suitability for your goals.
How to Invest in ETFs
Investing in an ETF can be straightforward from a trading perspective, but choosing the right ETF requires research.
Step 1: Define your investment goal
Start with the reason you are investing.
Are you investing for long-term wealth building, retirement, income, diversification, international exposure or another goal?
Step 2: Decide what asset exposure you need
Do you need stocks, bonds, international investments, a particular sector or another asset?
Step 3: Decide whether passive or active makes sense
Understand the difference between an index-tracking ETF and an actively managed ETF before selecting one.
Step 4: Research the ETF
Review the ETF's objective, holdings, strategy, benchmark, historical information, fees and risks.
Step 5: Check the costs
Look at the expense ratio, bid-ask spread, commissions if applicable, and other transaction costs.
Step 6: Check diversification
Look at the largest holdings, sector exposure, country exposure and concentration.
Step 7: Understand liquidity
Check trading activity and bid-ask spreads. Also consider the liquidity of the underlying assets.
Step 8: Use a suitable investment platform
Use a regulated and reputable brokerage or investment platform available in your country and understand its fees and investor protections.
Step 9: Place your investment carefully
Understand the order type you are using and the price at which the trade may execute.
Step 10: Continue monitoring the investment
You do not need to constantly trade an ETF, but you should periodically confirm that the investment still matches your strategy.
How to Choose an ETF
Thousands of ETFs can exist across global markets, so choosing one should begin with your objective rather than the ETF with the most attention online.
1. Investment objective
What is the ETF designed to accomplish?
2. Underlying index or benchmark
If it is an index ETF, understand exactly which index it follows.
3. Holdings
Know what you actually own indirectly through the ETF.
4. Concentration
Look at how much of the portfolio is represented by the largest holdings.
5. Expense ratio
Compare ongoing operating costs with similar ETFs.
6. Tracking difference
For index funds, investigate how closely the ETF has historically tracked its benchmark after expenses and other implementation effects.
7. Liquidity
Consider trading volume, bid-ask spread and the liquidity of the underlying securities.
8. Fund size and history
These can provide context, although neither guarantees future performance or investment quality.
9. Risk
Determine whether the ETF's volatility and underlying risks are appropriate for your financial situation.
10. Tax considerations
Tax treatment depends on the investor's country, account type and ETF structure. Do not assume that an ETF is automatically tax-efficient for every investor.
Common ETF Investing Mistakes
Mistake 1: Buying an ETF because it is popular
Popularity does not prove that an investment is suitable for your goals.
Mistake 2: Assuming every ETF is diversified
Sector, thematic and narrowly focused ETFs can be highly concentrated.
Mistake 3: Looking only at past returns
Strong historical performance does not guarantee future performance.
Mistake 4: Ignoring fees
Fees reduce returns, especially over long periods.
Mistake 5: Ignoring bid-ask spreads
Trading costs can matter, especially for less-liquid ETFs or frequent traders.
Mistake 6: Confusing NAV with market price
The market price can trade above or below NAV.
Mistake 7: Buying a complex ETF without understanding it
Leveraged, inverse and derivative-based products can behave very differently from ordinary diversified ETFs.
Mistake 8: Buying too many overlapping ETFs
Owning several ETFs does not automatically mean you are well diversified. Different ETFs can hold many of the same companies.
Mistake 9: Chasing distributions
A high distribution does not automatically mean a high-quality investment. Understand where the distribution comes from.
Mistake 10: Trading constantly
ETFs make frequent trading easy, but ease of trading can become a disadvantage if it encourages unnecessary decisions and costs.
ETF Scams and Red Flags
ETFs themselves are legitimate investment products, but scammers can use the names of legitimate ETFs, brokers, fund managers and financial institutions to make fraudulent offers appear credible.
Be cautious when someone promises:
- Guaranteed ETF profits
- Very high returns with no risk
- Secret ETF trading strategies
- Guaranteed daily returns
- Exclusive access requiring immediate payment
- Guaranteed profits from leveraged ETFs
- Pressure to deposit cryptocurrency to an unknown platform
- Unverified "investment managers" who cannot be independently confirmed
Verify before investing
Find the ETF independently through the legitimate fund provider, exchange or regulatory database rather than relying only on a link sent to you by someone online.
Verify the broker or investment platform separately and never assume that professional-looking branding proves legitimacy.
Beginner ETF Checklist
Before buying an ETF, ask yourself these questions.
- What is my investment goal?
- What does this ETF actually own?
- What index or strategy does it follow?
- Is it diversified enough for my needs?
- What are its largest holdings?
- What sectors and countries does it hold?
- What is the expense ratio?
- What other transaction costs might I pay?
- How wide is the bid-ask spread?
- How liquid is the ETF and its underlying holdings?
- How risky is the underlying investment?
- Does it use leverage, derivatives or inverse strategies?
- How does its market price compare with NAV?
- Does it fit my overall portfolio?
- Have I read the fund's official documents?
How ETFs Can Fit Into a Long-Term Investment Strategy
ETFs can be used in many different ways.
Some investors use a broad-market ETF as a core holding. Others combine stock ETFs and bond ETFs to create a diversified portfolio. Some investors use international ETFs to add geographic diversification.
Others use sector or strategy ETFs for smaller, targeted allocations.
The important distinction is between using ETFs as part of a deliberate strategy and simply collecting ETFs because they look attractive.
Core holdings
A broad ETF can potentially serve as a core holding because it can provide exposure to a large number of securities through one investment.
Satellite holdings
More specialized ETFs can sometimes be used as smaller satellite positions around a diversified core.
Portfolio balance
Investors may combine ETFs representing different asset classes to balance growth, income, diversification and risk.
There is no single portfolio structure that is appropriate for everyone. Your allocation should reflect your financial goals, time horizon and ability to tolerate losses.
ETFs for Long-Term Investors
One reason ETFs are popular with long-term investors is that they can make diversified investing relatively simple.
A long-term investor may choose a low-cost diversified ETF, contribute consistently and avoid reacting emotionally to every market movement.
But the long-term approach does not remove the need for research.
A fund's objective can change, its holdings can change, market conditions can change, and your own financial circumstances can change.
Periodic portfolio reviews can help you determine whether your investments still match your goals.
Do not confuse long-term investing with ignoring your portfolio
Long-term investing generally means giving an appropriate investment enough time to work rather than constantly buying and selling because of short-term market movements.
It does not mean buying an ETF once and never checking whether it remains suitable.
What Makes an ETF Worth Considering?
There is no single feature that makes an ETF good for every investor.
Instead, a strong candidate generally has characteristics that make sense for the purpose you are trying to accomplish.
Clear objective
You should understand what the fund is trying to achieve.
Appropriate diversification
The holdings should match the level of concentration you are comfortable with.
Reasonable costs
Fees and trading costs should be considered alongside the value provided.
Understandable risk
You should know what could cause the investment to lose value.
Suitable strategy
The ETF's strategy should fit your overall investment plan.
Good implementation
Consider tracking quality, liquidity, spreads and how efficiently the ETF implements its objective.
The Big Picture: Are ETFs Right for You?
ETFs are tools, not financial goals.
Their value comes from how appropriately they are used.
For one investor, a broad stock-market ETF may be a useful way to obtain diversified long-term equity exposure. For another investor, a bond ETF may provide the fixed-income exposure they are looking for. A third investor may have no reason to use a particular sector or thematic ETF at all.
The key is to start with the financial objective and then choose the investment vehicle that makes sense.
Do not start with a ticker symbol.
Start with the question: "What am I trying to accomplish with this money?"
Then determine which asset class, strategy and investment structure can reasonably help you pursue that goal.
Once you understand ETFs, you can compare them more intelligently based on diversification, costs, liquidity, risk, strategy and suitability rather than choosing based solely on popularity or recent performance.
Frequently Asked Questions About ETFs
What does ETF stand for?
ETF stands for exchange-traded fund. It is a pooled investment product whose shares generally trade on an exchange during the trading day.
What is an ETF in simple terms?
An ETF is a fund that holds a portfolio of investments and allows investors to buy shares representing an interest in that portfolio. ETF shares generally trade on an exchange.
Are ETFs safe?
ETFs are not automatically safe. Their risk depends on what they own and how the fund is structured. Investors can lose money when the underlying investments decline or when other ETF-specific risks occur.
Can you lose money in an ETF?
Yes. An ETF can decline in value when the securities or other assets it holds decline. Some ETFs can also experience additional risks involving leverage, liquidity, currency movements, credit or other factors.
How do ETFs make money?
Investors can potentially earn returns when the market value of the ETF increases and through distributions such as dividends or interest generated by the underlying portfolio.
Are ETFs good for beginners?
Some ETFs can be useful for beginners because they can provide diversified exposure through one investment. However, beginners should understand what an ETF owns, its strategy, costs and risks before investing.
Are ETFs better than stocks?
Not automatically. An ETF can provide diversification across many investments, while an individual stock provides concentrated exposure to one company. The better choice depends on the investor's objective and risk tolerance.
Are ETFs better than mutual funds?
Neither is universally better. ETFs and mutual funds can both provide diversified investment portfolios, but they differ in trading, pricing, fees, tax considerations and other characteristics.
What is an index ETF?
An index ETF is designed to track a specified market index or benchmark. It generally seeks to achieve approximately the same return as that benchmark before fees and implementation differences.
What is an actively managed ETF?
An actively managed ETF has an investment manager making portfolio decisions according to the fund's investment objective rather than simply attempting to replicate a specific index.
What is ETF NAV?
NAV, or net asset value, represents the value of an ETF's assets minus liabilities divided by the number of outstanding shares. It is a measure of the underlying portfolio's value per share.
Can an ETF trade above its NAV?
Yes. An ETF can trade above its NAV, which is called trading at a premium. It can also trade below NAV, which is called trading at a discount.
What is the bid-ask spread on an ETF?
The bid-ask spread is the difference between the highest price a buyer is currently willing to pay and the lowest price a seller is currently willing to accept.
Do ETFs have fees?
Yes. ETFs have operating expenses and may also involve trading costs, brokerage commissions or other expenses depending on the fund and investment platform.
What is an ETF expense ratio?
An expense ratio represents a fund's annual operating expenses as a percentage of its assets. The expenses are generally reflected in the fund's NAV rather than being billed separately to investors.
What are leveraged ETFs?
Leveraged ETFs seek to provide a multiple of the daily performance of a benchmark or index. Their daily-reset structure can create outcomes that differ substantially from simply multiplying the benchmark's longer-term return.
What are inverse ETFs?
Inverse ETFs seek to produce returns opposite to a benchmark over a specified period, often on a daily basis. They are more complex than ordinary diversified ETFs and should be understood before use.
How many ETFs should I own?
There is no universal number. Owning more ETFs does not necessarily improve diversification because different ETFs can contain many of the same securities.
How should a beginner choose an ETF?
Start with your financial goal and then examine the ETF's investment objective, holdings, diversification, fees, liquidity, strategy, risks and suitability for your portfolio.
Should beginners use leveraged ETFs?
Beginners should be especially cautious with leveraged ETFs because they use more complex strategies and often target daily returns. Investors should fully understand the mechanics and risks before considering them.
Do ETFs pay dividends?
Some ETFs distribute income generated by their underlying investments. For example, a stock ETF may receive dividends from companies it owns and distribute some of that income to shareholders, after applicable expenses and according to the fund's structure.
Can ETFs be used for retirement investing?
ETFs can be used as investments within retirement strategies where they are available and appropriate. The specific account rules, tax treatment and available products vary by country.
Key Takeaways
- ETF stands for exchange-traded fund.
- ETFs pool investor money into portfolios of securities or other assets.
- ETF shares generally trade on an exchange during the trading day.
- ETFs can provide diversification, but not every ETF is highly diversified.
- ETFs can be index-based or actively managed.
- ETF market price can differ from NAV.
- Bid-ask spreads can create trading costs.
- Expense ratios and other fees reduce investment returns.
- Bond ETFs can have interest-rate and credit risk.
- International ETFs can involve currency and geopolitical risks.
- Leveraged and inverse ETFs are more complex than ordinary diversified ETFs.
- Past performance does not guarantee future results.
- The right ETF depends on your goals, portfolio and risk tolerance.
- Always understand what an ETF owns before investing.
Understand the Investment Before You Buy It
ETFs can make investing more accessible, but convenience should never replace understanding.
Before buying an ETF, investigate its objective, holdings, costs, diversification, liquidity and risks. Then consider whether it actually belongs in your overall financial plan.
The strongest investment decisions are not necessarily the ones that produce the most excitement. They are the ones that make sense for the investor's goals, time horizon and ability to handle risk.
