What is an ETF?

Exchange-traded funds (ETFs) are similar to mutual funds in many ways. They typically track the price of a single asset (such as gold) or a basket of assets (such as the S & P 500), allowing investors to diversify their portfolios by investing in an entire asset class. As the name suggests, they are traded on exchanges and can be bought and sold through traditional brokerage accounts just like stocks.

In 2024, a number of U.S. companies, including BlackRock, Fidelity and Gray, successfully obtained approval from the U.S. Securities and Exchange Commission (SEC) to list on U.S. exchanges and trade spot BTC ETFs. These spot ETFs hold Bitcoin itself, which is different from approved Bitcoin futures ETFs.

Why are ETFs important?

ETFs are very popular. As of the end of 2023, US$11.63 trillion of assets were invested in ETFs globally, almost six times the number a decade ago. Due to the surge in interest in low-premium index investment, ETFs have spawned a whole new category of financial companies: so-called robotic advisers like Betterment and Wealthfront, which invest almost exclusively in ETFs.

So it may be time to finally understand what they are. Think of ETFs as ordinary cousins of stocks and mutual funds. Although mutual funds have been around for nearly 100 years, ETFs did not appear in the United States until 1993, when State Street Capitol launched its S & P 500 mirror ETF(\"Spider\" for short), which is still traded today.

How do ETFs work?

Like individual stocks, ETFs are listed on exchanges such as the New York Stock Exchange, Nasdaq and Shanghai Stock Exchange. Like stocks, their share prices fluctuate up and down during the trading session-a major difference between ETFs and mutual funds. The net asset value of a mutual fund, or NAV, is almost always priced only once a day, usually after the close of the exchange. ETFs usually track the prices of their components dynamically, adjusting by buying and selling components, whenever the price of any of them starts to differ.

Like mutual funds, most ETFs serve as a packaging that contains many individual securities. This makes mutual funds and ETFs a natural attraction for retail investors to diversify their portfolios by adding many stocks, bonds or other types of investments in one purchase.

Compare ETFs and mutual funds

1. These two asset classes are similar in many ways. But there are many interesting differences.

2. Mutual funds may or may not require a specific minimum investment amount. ETFs, on the other hand, are sold by share or partial share, providing a lower barrier to entry.

3. ETFs are issued by well-known companies like Vanguard and Schwab, but unlike mutual funds, they are usually not purchased directly from the fund issuer, but from another investor on the stock exchange.

4. Because they are actively traded in the market, the price of ETFs sometimes deviates from the value of their underlying investments. (Generally, however, the price of an ETF is very close to the price of its underlying asset.)

5. Unlike many mutual funds, ETFs are usually passively managed-which means that no human fund manager bends over in front of a Bloomberg terminal to decide which stocks to add or remove from the fund. Instead, computer algorithms usually do the main job of executing ETF transactions. Because they do not have to pay a fund manager\'s salary, ETFs typically have lower operating costs and expense ratios than actively managed mutual funds.

6. Because mutual fund managers may engage in large transactions that buy and sell fund assets, their funds may incur large capital gains taxes-which may have a negative impact on returns. ETFs typically reflect the composition and weight of existing indices-for example, the S & P 500 index for large-cap stocks, the Russell 2000 index for small-cap stocks, or the Bloomberg Barclays Treasury 1-3-Year Index for Treasuries.

7. ETFs can also track markets for single assets, such as gold ETFs. Bitcoin ETFs would be similar to such funds.

Professional ETF

ETFs are not all passive. Take the popular ARK Innovation ETF(ARKK) as an example, which actively invests in companies that its manager Cathy Wood considers disruptive, such as Tesla. These ETFs are not cheap-ARKK charges a fee of as high as 0.75%(which represents the portion of the fund\'s assets used for administrative and other operating expenses), which puts its holding costs on par with popular mutual funds such as Fidelity Magellan. Other ETFs are almost the same products as mutual funds offered by the same company. Vanguard Group, a company that revolutionized low-rate investing, also offers passively managed mutual funds and ETFs that track the S & P 500. (Although they provide nearly the same returns, the ETF version may be more attractive because mutual funds require a minimum investment of $3000.) While index-tracking ETFs are most popular among retail investors, there are countless other types of ETFs, from industry ETFs (such as those that specialize in investing in technology or marijuana companies) to \"themed\" ETFs (such as those that allow Catholics to invest only in companies that follow guidelines set by the U.S. Synod of Bishops). Of course, there are many investment options with complex financial terms, such as leveraged ETFs, which amplify market gains and losses, and reverse exchange traded funds, which are designed to make a profit when their underlying index falls. Before investing in an ETF, it\'s best to review all disclosures (usually on the ETF\'s website) to make sure you understand what you\'re buying. If you have any questions about financial strategy, it is recommended to consult a licensed investment adviser.