By James Celentano in Asset Allocation — 18 Feb 2025

The Basics of ETFs: What Every Investor Should Know

Exchange-Traded Funds (ETFs) have become one of the most popular investment vehicles for both new and seasoned investors. They offer a simple, cost-effective way to gain exposure to a diversified portfolio of assets. But what exactly are ETFs, how do they work, and why have they gained such widespread appeal?

What Are ETFs?

An ETF is a type of investment fund that holds a collection of assets, such as stocks, bonds, or commodities, and trades on an exchange like a stock. Unlike mutual funds, which are typically priced once per day, ETFs can be bought and sold throughout the trading day at market prices. This liquidity and flexibility make them an attractive choice for many investors.

How ETFs Work

ETFs function similarly to stocks in that they have a ticker symbol and can be traded on major stock exchanges. When an investor buys shares of an ETF, they are purchasing a proportional stake in the underlying assets. Most ETFs aim to track an index, such as the S&P 500, replicating its performance by holding a similar mix of securities, and other ETFs are actively managed, meaning fund managers make decisions about which assets to include.

Advantages of Investing in ETFs

One of the primary benefits of ETFs is diversification. Because an ETF holds multiple securities, investing in one can reduce the risk associated with holding individual stocks. Additionally, ETFs often have lower expense ratios compared to mutual funds, making them a cost-effective option. They also offer tax efficiency since they tend to generate fewer capital gains distributions than actively managed funds.

Another significant advantage is accessibility. ETFs allow investors to gain exposure to different asset classes and market sectors without needing to buy individual stocks or bonds. Whether someone is interested in domestic equities, international markets, or niche sectors like technology or healthcare, there is likely an ETF available to meet that need.

Types of ETFs

ETFs come in various forms, each catering to different investment strategies and risk profiles. Broad market ETFs track major indexes, while sector ETFs focus on specific industries. Bond ETFs provide access to fixed-income investments, and commodity ETFs hold physical assets like gold or oil. There are also inverse and leveraged ETFs designed for short-term trading strategies, though these come with higher risk.

Considerations When Investing in ETFs

While ETFs offer many advantages, investors should evaluate a few key factors before investing. nderstanding the composition of an ETF is essential, as some funds may be more concentrated in certain stocks or sectors than others.

Final Thoughts

ETFs provide an efficient and flexible way to invest across a broad range of assets. Their combination of diversification, cost-effectiveness, and accessibility makes them an excellent choice for building a well-balanced portfolio. However, as with any investment, conducting thorough research and aligning ETFs with personal financial goals is essential for long-term success. ETFs offer many advantages as they're simple to use and relatively inexpensive when you consider all options. It is essential for investors to understand the composition of an ETF before buying, as some funds may be more concentrated in certain stocks or sectors than others. Here are some of the most popular ETFs to consider..

Vanguard S&P 500 ETF (VOO) Tracks the S&P 500, offering exposure to 500 of the largest U.S. companies with low fees.

SPDR S&P 500 ETF Trust (SPY) The first and one of the most traded ETFs, also tracking the S&P 500, with high liquidity.

iShares Core S&P 500 ETF (IVV) Another S&P 500 tracker with a slightly lower expense ratio than SPY, popular among long-term investors.

Vanguard Total Stock Market ETF (VTI) Covers the entire U.S. stock market, including large, mid, and small-cap stocks, offering broad diversification.

Invesco QQQ Trust (QQQ) Tracks the Nasdaq-100, focusing on tech-heavy growth stocks like Apple, Microsoft, and Amazon.