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Exchange-Traded Fund
- Charles Lin
- Aug 13, 2021
- 2 min read
Updated: Nov 28, 2022
Introduction
What is an exchange-traded fund? An exchange-traded fund is a collection of stocks all
bundled into one basket. The basket can then be bought and sold on a stock exchange just like a regular stock. They are commonly abbreviated ETFs. If this sounds similar to you, then good for you! ETFs are very similar to mutual funds. If you don’t know what a mutual fund is, check out my article on them here (Part 1 Part 2).
Stock Indices
Typically, an ETF models itself after a stock index. If you don’t know what an index is, it basically is a listing of several stocks and tracks how well these stocks do as a whole. You can
read the article on stock indices for more details here. For example, a very popular ETF, called the SPDR S&P 500 (Ticker: SPY) contains all the stocks from the S&P 500 index. When the S&P 500 does well, the price of SPY increases, and when the S&P 500 does poorly, the price of SPY decreases.
Trading
ETFs are traded the same way as a regular stock. They are bought and sold on the same stock exchanges as stocks, and can be traded during the same hours (9 am - 4 pm EST). Similarly to stocks, the price of an ETF is determined by demand. When a lot of people want to buy into an ETF, the price increases, and when a lot of people sell their shares of an ETF, the price decreases.
Risk
One of the biggest reasons why people invest in ETFs is because they are safer than regular stocks. This is because of a concept called portfolio diversification. If you don’t know what diversification is, it's basically when a portfolio has many different stocks from different industries. For more information, you can read my article on diversification here.
An ETF, by definition, is pre-diversified because it contains many different stocks. If one stock in the ETF crashes but others have a field day and climb very high, that one stock that fell wouldn’t have a large impact. In this way, ETFs are a very good investment to make for people that don’t want a lot of risk, since they have less risk than individual stocks, but still have good returns.
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