An exchange traded fund (ETF) is a collection of stocks or bonds that you can purchase for a single price.
- Why do people invest in ETFs?
- What kinds of ETFs are there?
- What's the difference between an ETF and a mutual fund?
Why do people invest in ETFs?
Many people invest in ETFs because they:
- have extremely low fees
- give you more exposure to the market than simply buying an individual stock
- typically offer better returns over time than trying to pick individual stocks
Buying and selling ETFs is very easy to do, which has made them accessible to more people. There is no minimum to invest (just the price of a single share of the ETF). And since ETFs trade on the stock market, buying a unit is as simple as buying a share in a company.
As an added bonus, ETFs also collect dividends from the various companies and pass the money onto you.
What kinds of ETFs are there?
There are many different kinds of ETFs, all of which include tens, hundreds, or sometimes thousands of other assets. For example:
- Stock Market Tracking ETFs
These ETFs mirror certain indices in the stock or bond market. They have attracted by far the most investment from individual investors. Some of the most popular stock market ETFs track the S&P 500, which is an index of the 500 publicly-traded American companies with the highest market capitalizations.
- Sector Tracking ETFs
These ETFs track particular sector of the economy, rather than the entirety of it. Individual sectors can be as broad as energy, healthcare or information technology.
- International ETFs
There are all kinds of international ETFs for investing in international markets. They focus on things like economies outside the US, individual countries, developed markets, emerging markets and more.
- Thematic ETFs
These are ETFs which invest according to a theme, like ‘socially responsible investing’, ‘halal investing’, or even something like ‘marijuana stocks’.
What's the difference between an ETF and a mutual fund?
The main difference between an ETF and a mutual fund is that a mutual fund is actively managed by a fund manager, who picks specific stocks with the goal of trying to outperform the market.
On the other hand, many ETFs are programmed with an algorithm that simply tracks an entire economic sector or index, like the S&P 500 or the US bond market.
Mutual funds have higher management fees than ETFs, and more often than not, don't succeed in beating the market.
While most mutual funds charge more than 2% a year, ETFs charge fractions of a percentage point (typically in the range of 0.05 to 0.25%). Over the course of many years, these fees can make a huge difference to your returns.
ETFs are so much cheaper than mutual funds because they track an entire genre of investments. They aren’t trying to guess individual winners in the stock or bond markets and so fund managers don’t need to make a large number of trades. This helps keep costs down.
For this reason, you’ll often hear people talk about mutual funds as being “actively managed” and ETFs as “passively managed” – although there are many exceptions to this rule.