An exchange traded fund, or ETF, is a basket of investments that trades on an exchange like a single share. Buy one unit and you own a small piece of everything in the basket.
In short
- An ETF holds many investments; a stock is one company.
- Most ETFs follow an index, such as the largest companies in a market.
- The expense ratio is a yearly fee taken from the fund, and small differences compound.
- Always check what is inside: two funds with similar names can hold very different things.
How an ETF works
A fund company gathers money from investors and buys a set of assets, often the companies in an index such as the S&P 500. The fund is split into units that trade on an exchange throughout the day. When the companies inside rise or fall, the unit price follows.
Because it trades like a share, you buy and sell an ETF through the same broker account, at a market price, during market hours.
ETF or single stock
| Single stock | ETF | |
|---|---|---|
| What you own | Part of one company | Small parts of many |
| If one company fails | You can lose most of it | A small slice of the fund is affected |
| Yearly cost | None from the company | An expense ratio, taken from the fund |
| Research needed | A lot, company by company | Mostly understanding the fund and its index |
| Upside | Can outgrow the market | Roughly matches what it tracks |
Neither is better in general. Many investors hold a broad ETF as the core of a portfolio and a few individual companies they understand well around it.
The expense ratio, worked through
The expense ratio is the yearly fee, expressed as a percentage of what you hold. It is taken quietly from the fund, so you never see a bill.
On the same holdings, a fund charging 0.75 percent a year ends up roughly thirteen percent smaller after twenty years than one charging 0.05 percent, because the fee is taken every year from a growing balance. That is compounding working against you.
A fee you never see is still a fee you pay, every single year.
What to check before you buy
- What index or strategy does it follow, in one sentence?
- What are its largest holdings, and how much of the fund do the top ten make up?
- What is the expense ratio?
- Does it pay out dividends, or reinvest them inside the fund?
- Which currency is it priced in, and which currency are the holdings in?
The last question matters if you invest from outside the fund’s home market: currency moves change your return as well as prices. On TruVest you can open any ETF to see its chart and what investors who hold it are saying, from the Markets tab.
Common questions
Is an ETF safer than a stock?
An ETF spreads money across many holdings, so one company failing does far less damage. It still falls when the whole market falls.
What is an expense ratio?
The yearly fee a fund charges, as a percentage of what you hold, taken from the fund rather than billed to you.
Do ETFs pay dividends?
Many do, passing on dividends from the companies inside. Some reinvest them inside the fund instead; the fund’s name or documents usually say which.
What is the difference between an ETF and a mutual fund?
An ETF trades on an exchange during the day at a market price. A traditional mutual fund is usually bought from the fund company at a price set once a day.