What is an ETF?

An exchange-traded fund (ETF) is an easy way to get exposure to a broad range of stocks.

An ETF is a collection of securities (stocks, bonds, futures, etc.) that a management firm has purchased; it sells shares in the ETF to investors, so that investors own shares of the fund, though not of the individual securities within it.

Investors can buy and sell shares of the ETF as they would shares of a stock. Investors buy ETF shares via a brokerage, and pay a commission on the trade.

One of the most popular ETFs is the SPDR S&P 500 ETF Trust, which tracks the stocks in the broad S&P 500.

ETFs have certain advantages:

  • ETFs come in great variety, enabling you to invest in a broad range of securities that you ordinarily wouldn’t have easy access to.
  • ETFs are often passively managed. That is, they conform to an index and do so on the basis of an algorithm. This means expense ratios are minimal.
  • There is generally no discount or premium to net asset value. The share price accurately reflects the value of the underlying securities.

When to buy an ETF:

  • When you want portfolio exposure to the index and don’t want to spend the time researching individual securities within that index.
  • When that index is specialized. For example, if you want exposure to a type of stock, such as stocks that are growing dividends, an unusual kind of security, such as preferred shares, or stocks of companies in an individual country.
  • You don’t mind paying a commission on your investment, because you want to benefit from the low expense ratio.

Got 60 more seconds to invest in figuring out what role ETFs can play in your portfolio? Check out this Foolish 60-second guide to ETFs. If you want to know more about how ETFs differ from mutual funds, go here.

— Answer provided by Fool member Paul Thomas.

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