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What are Etf's aka Exchange Traded Funds?

Updated on April 5, 2013

ETF's: Simple Definition and Explanation

ETF stands for Exchange Traded Fund. The fund is traded realtime on the stock exchange, very much like stocks. As opposed to a mutual fund that doesn't trade realtime but can be entered or exited after the market closes.

An ETF is similar to a mutual fund in that it can hold any number of assets, like stocks, bonds, and commodities. Usually they are designed around a stock or bond index that is already popular.

An ETF has the best of two worlds. It is like a mutual fund in that it can be bought and sold at net asset value of the securities in it. On the other hand the ETF can be traded during the day, while the market is open, just like stocks or closed end funds.

ETF's were first started as index funds but since 2008 the U.S Securities and Exchange Commission has allowed actively managed ETF's to be created. Most people still refer to ETF's as if they are index funds. In many cases that's correct, but not always.

Definition of Exchange Traded Fund (ETF)

Princeton's definition is easy, correct and flexible:

ETF: a mutual fund that is traded on a stock exchange


Advantages of the ETF fund

  • With ETF's it's easy to diversify across many asset classes and individual securities
  • Lower Costs of ETF's. ETF's have relative low costs because they are usually not actively managed and don't have to buy and sell securities to meet shareholder purchases and redemptions.
  • ETF's are tax efficient: ETF's usually don't have very high capital gains tax
  • ETF's are transparant. With an ETF you always know what your $ is worth.

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Index ETF

As I have mentioned before most ETF's are index funds. They track some kind of index, whether it be the S&P 500 or the Dutch AEX index. They can also be based on underlying baskets of commodities, currencies or bonds.

Stock ETFs

The majority of ETFs are designed to track stocks. International indexes like the MSCI Global or the Vanguard Total Stock Market ETF. They can also track stocks in a sector like Mining or Green Energy etc.

Bond ETFs

Bond ETF's track an underlying basket of Bonds. For example Emerging Market Junk Bonds or European Bonds or USA 30 yrs bonds. The possibilities are virtually endless. Fees can be reasonable but it depends on your broker.

Commodity ETF funds

What are Commodity ETF funds? There are also ETF funds tracking baskets of commodities or just one underlying commodity or derivative. The most famous one being the SPDR Gold Shares ETF. In November 2010 it was briefly the 2nd largest ETF in the world.

Currency ETFs

Currency ETF's track a underlying currency or a basket of underlying currencies. It's a easy and relatively low cost way to make a bet on a currency. Rydex, Deutsche Bank and Sterling Money Market all have currency ETFs on the market.

ETF companies

Major companies offering ETF's in the US and Global right now are:

  • BNP Paribas
  • Blackrock (well known Ishares)
  • Charles Schwab (discount options for clients)
  • Deutsche Bank (issues some Powershares)
  • Invesco (involved with Powershares too)
  • Lyxor ETFs
  • Merrill Lynch
  • Vanguard Group (Vanguard ETF's)



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