ETF Academy What is an ETF?

What is an ETF?

ETFs are the modern way to invest in a diversified manner. Individuals with small amounts of capital can benefit from features previously only enjoyed by large institutional investors, such as pension funds. Most ETFs are index funds. In the following sections, we'll go through the main aspects of ETFs, starting from the question, what an ETF is.

What is an ETF? The basics of exchange-traded funds

An ETF is a fund that trades on a stock exchange. The first ETF was introduced in 1993. It was a significant innovation in finance for the reasons below.

In a nutshell, the ETF is the simplest way to "buy the index," as someone can acquire an ETF in a single transaction on a stock exchange. It’s an innovation that democratizes investment; arguably, its full potential is yet to be appreciated.

 

Why are ETFs so popular?

 

Easy access

to international markets, asset classes, and investment strategies previously available only to institutional investors.

Transparency

With exchange-traded funds, you know which stocks or other assets are in the fund and how they are selected for inclusion.

Helps reduce risk

Because your investment in an ETF is spread across a number of stocks or other assets, it is considered less risky because you are not dependent on the growth of any company or asset.

You don't need a lot of money to invest in ETFs

ETFs are a way to invest small amounts of money in multiple companies or other assets.

Lower costs

Management fees for index-based ETFs are typically lower than investing in the same exposure to individually purchased companies.

ETFs vs mutual funds

Explaining "what is an ETF?" and why ETFs have advantages over mutual funds can get complicated. Below are three main advantages:

1. Costs: ETFs are far cheaper than mutual funds. As discussed in the previous module, this logically translates into higher returns over time.
2. Transparency: ETF managers have the virtue of being transparent. They publish total expense ratios, which show all the costs an investor has to pay. By contrast, mutual funds costs are often opaque, with little reference to trading or operational expenses. Additionally, you know exactly what you’re investing in with an ETF, as the index’s constituents are publicly known. Mutual funds require more trust from investors. There are too many instances of mutual fund managers straying from what they said they were investing in, with bad consequences for their investors.
3. Liquidity: ETFs are bought and sold on stock exchanges. You can buy and sell whenever the stock exchange is open through an online brokerage account. You also know exactly the price you’ve paid. What could be simpler? By contrast, mutual funds transactions are typically only executed at the end of the day, and the price is only set at that moment.

Investors should consider risks, i.e., the risk of capital loss, before investing.

The following table summarizes the differences between ETFs, mutual funds, and individual stocks, thus perfectly addressing the question, "What is an ETF?" and how it stands out related to other asset classes.

ETFs compared to other products

Source: VanEck.

ETF investing

ETFs are transforming the world of investing; more people are always getting to know and understand what an ETF is. It lets you create a well-diversified portfolio with minimal costs. Theoretically, the professional investor’s world is within reach of the private individual. Nowadays, ETFs cover all standard asset classes – from shares (stocks) to bonds and commodities. Beyond that, thematic ETFs allow investors to invest in an economic theme they believe is prospering, such as semiconductors for computing or renewable energy. Continue our Academy Course to learn more about ETFs and how can you invest in them through VanEck.

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