What the Heck is an ETF? The 411 on Exchange-Traded Funds

If you’ve made it this far, you should be a bit familiar with Mutual and Index Funds as investment products, the similarities and differences between them.  Now we’re going to throw another mix into the pot- and they’re called ETFs.

What the heck is an ETF- right?  ETF stands for Exchange-Traded Funds.  The easiest way to explain it is like this: An ETF is an Index Fund that trades like a stock on an exchange, therefore the price fluctuates throughout the trading day.

If you’ve already forgotten what an Index Fund is, it’s like a Mutual Fund- a fund that’s mutual, pretty much like this- a group of investors get together (no, they don’t know each other) and buy a fund that has been invested by a fund manager into a specific group of stocks, bonds, or other securities, like the “International Small Business Fund”, comprised of a basket full of small businesses from around the world..  Index Funds are not based on a “group” of stocks, but rather a commodity or an entire Index’s performance, like the S&P 500.

Since this financial product tracks the index and trades like a stock, the value isn’t calculated at the end of each day like a Mutual Fund, but throughout the day based on the laws of supply and demand, just like the stocks in the market. One point worth a mention is that even though an EFT tracks a particular index, there is no guarantee that the two will match up perfectly. (I know—kind of weird).

Another similarity between ETFs and index funds is the manner in which they are both “Passively Managed”, which in normal jargon means that there isn’t a high commissioned individual at the investing end of this product- this simply “mirrors the index”.  This means that any and all attached fees are going to be significantly lower than with an “Actively Managed” mutual fund, where a fund manager might just have a family to support.

At last count, there were a little over 200 ETFs for you to choose from, tracking just about every industry that you can think of. That number is substantially less than the 8,000+ mutual funds in the US alone (over 55,000 worldwide).  Some of the most popular ETFs have nicknames like “cubes”, short for the NASDAQ-100 Index Trading Stock with a ticker-symbol of QQQQ (Q to the fourth power, or Q-cubed- now ”cubes” for short). This particular ETF was the most heavily traded of the all between 2000 and 2004.

Another nickname for a popular ETF is “spider”- short for the S&P 500 Index Fund and it’s ticker symbol of SPDR. This was actually the very first ETF that hit the floor of the American Stock Exchange (AMEX) back in 1993. A nice feature of spiders is that they divide up specific areas of the S&P 500, like the “Technology Select Sector Index” that trades as XLK on the AMEX.  This area covers over 85 different stocks of companies like defense manufacturers and producers of telecommunication equipment.

As with any investment, be sure to do research and contact a financial advisor, preferably a friend that won’t rip you off, before handing over any of your hard-earned money.

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