Exchange-traded funds (ETFs) are investment vehicles similar to mutual funds.
Like mutual funds, ETFs are professionally managed baskets of investments that pool many investors’ money together. Also like mutual funds, ETFs can be great tools for putting together a broad, well-diversified portfolio.
However, there are some key differences between the two. Here are the important distinctions:
|Main difference||Shares trade on exchanges just like stocks, meaning you can watch the price go up and down throughout the trading day||Shares are valued and traded once a day, not throughout the day|
|How and when you can trade||Buy and sell shares throughout the trading day with a broker just as you can with stocks||Buy or redeem shares once a day—with a broker or with the fund company itself|
|Index vs. active||Most are index funds—meaning they track an index’s performance instead of trying to beat the market||Some are index funds, but many are actively managed funds, meaning a manager tries to pick only the best investments|
|Taxes||Usually generate minimal tax bills as long as you hold onto your shares||Can generate substantial tax bills even if you hold onto your shares|
Most ETFs are “indexed,” which means they try to match the performance of a specific index (such as the Dow Jones, S&P 500, or Nasdaq) as closely as possible. The fund does this by buying all of the index’s stocks and bonds (or at least a good sample of them) and holding them in the same proportions as the index.
Other ETFs are actively managed. Their investment managers try to beat the performance of a market index by picking specific investments that they think will have above average returns. While that might sound like a great way to make more money, these sometimes come with a few downsides, including:
ETFs can also be good tools to help investors fill a portfolio niche or reflect a special interest. For example, some of the more narrowly focused ETFs may only invest in:
That’s why many investors like to use ETFs as building blocks for their portfolios.
ETFs have become incredibly popular in recent years for a few reasons:
An exchange-traded fund (ETF) is a collection of stocks and bonds (or other securities) pooled into a single fund. You can buy and sell shares of ETFs on a stock exchange the same way you buy and sell stocks. Although they’re very similar to mutual funds, unlike mutual funds, you can trade ETFs throughout the trading day.