What Is an ETF?

April 22, 2025

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ETF stands for exchange-traded fund. It is a type of fund that invests in a large collection of asset classes, which may include stocks, bonds, or other types of securities.

ETFs can be appealing to new and veteran investors alike given their potentially low investment costs and built-in diversification. If you’re interested in adding ETFs to your portfolio, here's what you need to know before getting started.

Exchange-traded funds: a closer look

As the name implies, an ETF is a type of investment fund that can be traded on a stock exchange. If you take a peek inside one of these exchanged-traded funds, you’ll see that an ETF holds a large collection or "basket" of investments. A single ETF can hold a variety of bonds (bond ETF), stocks (stock ETF), commodities (commodity ETF), or other types of assets.

For instance, when you invest in a stock ETF, you’re not buying shares of an individual stock. Instead, you're buying shares of that ETF, which allows you to invest in a number of different stocks all at once. An ETF can include stocks from companies across various industries or from a specific sector (like energy).

ETFs can be structured in many different ways. For example, they can be built to track (or follow) certain indices, such as the S&P 500.

ETFs could help you build a diversified portfolio

Because of their range of assets, many ETFs have a certain degree of diversification built in. Generally, ETFs are less risky than investing in a single stock or bond given that an ETF can help spread risk across a number of different investments.

Also, since you don’t have to buy the underlying assets (assets inside the fund) individually, investing in different types of ETFs could be a time-saving, cost-effective way to build a diversified portfolio.

However, that doesn't mean ETFs are risk-free (no investment ever is), as diversification alone doesn't guarantee a profit nor can it completely protect you against loss.

Keep in mind that certain ETFs can be concentrated in specific industries or geographies (e.g., international and emerging markets ETFs), so some funds may be less diversified than others. If you want to get a better sense of an ETF’s level of diversification, you can take a look at the fund’s prospectus, which you can get from your broker or on the SEC's EDGAR site.

ETFs vs. mutual funds

ETFs may sound similar to mutual funds in that they can help you invest in a variety of stocks, bonds, and other securities.

But they are not the same. Here are some key differences:

How they are traded. ETFs can be traded on exchanges, including stock markets like the NASDAQ and NYSE, during the day when the markets are open. Mutual funds, on the other hand, are not traded on an exchange. Shares are bought and sold once per day when the market closes. And transactions are done directly through the mutual fund company (or a broker for the fund).
Pricing. Because ETFs are traded on an exchange, their share prices can fluctuate throughout the day as shares are bought and sold. With mutual funds, however, their share prices are based on the fund’s net asset value, which is calculated at the end of each trading day.
Reporting. Another key difference has to do with the frequency of reporting when it comes to disclosing a fund’s investment holdings. Many ETFs provide a daily disclosure of their holdings, while mutual funds are only required to report their holdings quarterly.

ETFs and mutual funds also come with different tax considerations, so it's a good idea to consult a tax professional if you have any questions. Whether you choose to go with ETFs or mutual funds (or a combination of both) will depend on your personal investing goals and preferences.

Things to consider before investing in ETFs

With so many types of ETFs to consider, doing some research before you invest could help you avoid taking on more risk than you’re comfortable with as well as any unwanted surprises when it comes to costs and fees (like trading costs, expense ratio, and management fees).

Keep in mind that while ETFs could provide an affordable way to access a variety of investments, not every ETF is considered “low-cost.” For example, actively-managed ETFs tend to have higher fees compared to passively-managed funds.

In addition to understanding costs and risks, here are some other things to pay attention to when evaluating ETFs (and really any investment you’re thinking about).

Investment philosophy and investment objectives of the fund’s sponsor (or provider). A company’s investment philosophy gives you an idea of their overall approach to investing. (This information will be in the ETF's prospectus). By understanding the thinking and investment strategies at work behind the scenes, you can decide whether their investing style makes sense for you, your risk tolerance, and financial goals.
Performance. This includes asking questions like: When was the fund created? How has the fund performed over time (under both good and volatile market conditions)? In other words, you're looking for the expected return on investment, and the prospectus can provide some of these insights.
Taxation. Different ETFs are taxed differently, so it’s important to consult a tax advisor to understand how your returns from a particular fund will be taxed.

How to invest in ETFs

To invest in ETFs, you’ll need a brokerage account. And how you choose to invest will depend on your personal investing style and preferences.

For example, you could build your own ETF portfolio by handpicking ETFs yourself. Some brokerage firms offer their own proprietary ETFs that you can choose from. These proprietary funds are typically managed by the firm’s own team of investment professionals.

Or you could take a more hands-off approach and invest in ETFs through an automated investing service, like a robo-advisor. Automated investing typically uses algorithms to help you choose an appropriate investment strategy for your goals and manage your portfolio.

Either way, before making any investment decisions, talk to a financial advisor to see how ETFs can fit into your overall investment strategy.

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