What is an ETF?
An Exchange Traded Fund (ETF) is a security that owns a basket of assets (like stocks or bonds), the ownership of which is divided into shares. It is often compared with an “open-end mutual fund,” which is also a basket of assets. One of the main differences between the two, however, is that an ETF trades on an exchange (like the New York Stock Exchange) throughout the trading day. A regular (or “open end”) mutual fund, on the other hand, normally only trades once a day. All the investors in a mutual fund will get the same price when the fund trades at the end of the day.
Another difference is that mutual funds are often actively traded, and therefore may have greater internal management fees. ETFs that track an index (like the S&P 500, Dow Jones Industrial Average, NASDAQ) consist of a set selection of securities, and therefore investors miss out both on active management and higher trading fees.
Why do people invest in ETFs?
- Since the ETF encompasses many different assets divided into shares, it has built-in diversification. There are different types of ETFs specializing in different sectors, so you can choose the type of ETF that suits you.
- As ETFs are a marketable investment, they can be traded throughout the day.
- ETFs tend to cost less than mutual funds because they aren’t actively managed, and so their fees are lower.
What you need to know when considering an ETF
ETFs are not risk-free, as they are affected by market volatility. Moreover, if you own an ETF that holds stocks, you are exposed to the stock market. The fact that the ETF itself is diversified does not guarantee your principal.
If you are considering an investment in any fund, be sure to read the prospectus before investing. For more information about ETFs, listen to a 9-minute podcast at: Profile-Financial.com/etf
Douglas Goldstein, CFP®, is the Director of Profile Investment Service, Ltd., which specializes in helping people who live in Israel with their US dollar assets and American investment and retirement accounts. He helps olim meet their financial goals through asset allocation, financial planning, and using money managers.
Published March 13, 2017. Updated July 2021