An exchange-traded fund (ETF) is a single investment that holds many others. Buy one share of an S&P 500 ETF and you own a thin slice of 500 companies at once. It trades on the stock market like any individual stock, so you can buy or sell it whenever the market is open.
Why people use them
- Instant diversification. One purchase spreads your money across dozens, hundreds or thousands of holdings, so no single company can sink you.
- Low cost. The biggest index ETFs charge a few hundredths of a percent a year. On $10,000, a 0.03% fee is $3.
- Tax efficiency. ETFs rarely pass capital gains on to shareholders, which matters in a regular taxable account.
- Flexibility. There are ETFs for the whole market, single sectors like semiconductors, bonds, international stocks, gold and more.
ETF vs mutual fund
| ETF | Index mutual fund | |
|---|---|---|
| How it trades | All day, at market prices | Once a day, at the closing price |
| Where you can buy it | Almost any brokerage | Often cheapest at its own company |
| Automatic dollar investing | Depends on the broker | Easy: invest exactly $100 a month |
| Taxes in a taxable account | Usually very efficient | Can distribute capital gains |
For a long-term investor, both work well. The difference matters most in taxable accounts and when choosing which brokerage to use.
Three numbers to check before buying any ETF
- Expense ratio: the yearly fee as a percent of what you invest. Lower is better, all else equal.
- What it tracks: the index or strategy behind it. "AI ETF" can mean very different things depending on the holdings.
- Top holdings and their weights: many funds are more concentrated than their names suggest. Look at how much the top 10 stocks make up.
The catch
An ETF is only as good as what it holds. A broad index ETF is diversified; a narrow thematic ETF can be just as risky as a handful of stocks. And owning several ETFs doesn't automatically mean you're diversified, because they often hold the same companies. That's covered in ETF overlap, explained.