What is an ETF?

An ETF — exchange-traded fund — is a basket of investments that trades on a stock exchange as if the whole basket were a single share. One purchase buys the basket; the basket is the product. Most ETFs track an index, which makes them the tradeable cousin of the index fund.

The one real difference: how you buy it

A traditional fund is bought from the fund company, usually once a day at a price set after markets close. An ETF is bought on the exchange from another investor, any moment the market is open, at whatever price the market shows right now. Everything that follows — spreads, live prices, the ticker — flows from that single difference.

How the price stays honest

An ETF has two values: the market price you trade at, and the value of everything inside the basket (the net asset value). They stay close because specialist firms are allowed to build new ETF shares by delivering the underlying basket to the fund, or take ETF shares apart into the basket. If the ETF price drifts above the basket's value, assembling new shares and selling them is profitable — which pushes the price back down. The reverse trade catches drifts below. You never see this machinery; its effect is that the price you pay normally sits near what the contents are worth.

What it costs

Three costs, two of them easy to miss. The yearly charge is published and taken from inside the fund. The spread — the gap between the buying and selling price on the exchange — is paid every time you trade, and widens for thinly-traded funds. Your broker's dealing commission, where one exists, is the third. A cheap ETF traded often can cost more than an expensive one held for years; the arithmetic depends on your behaviour, not just the fund's fee line.

What the wrapper does not change

"ETF" describes the packaging, not the contents. The basket can hold broad stock indexes, bonds, single countries, single industries, or exotic strategies with leverage inside — the three letters stay the same. The risk is always the contents' risk: an ETF of volatile assets is volatile, and can lose money exactly as its contents can. What leverage inside a product does to that arithmetic is covered in what is leverage in trading.

What this is not

Nothing here says whether an ETF fits your situation, or which one to choose — costs, taxes and account types differ by country, and this page does not know yours. It explains the machine so that the words on a fund page mean something when you read them. For how funds fit among the ways money earns money, start at how people make money.