What are ETFs, and how do they work?

ETFs, or exchange-traded funds, are investment funds traded on stock exchanges just like individual stocks. They hold a collection of assets such as stocks, bonds, or commodities. Investors buy shares of the ETF, which represent a portion of the fund's holdings. ETFs offer diversification, lower fees, and flexibility in trading.

Is an ETF better than a stock?

ETFs and stocks serve different purposes. ETFs offer diversification, spreading risk across multiple assets, which can be safer for beginners. Stocks can offer higher returns but come with higher risk. It depends on your investment goals and risk tolerance.

What is better: ETFs or mutual funds?

ETFs are often better for lower costs, flexibility in trading, and tax efficiency. Mutual funds are better for automatic investments and not needing to actively manage trades. The best choice depends on your investing style and preferences.

Exchange-Traded Fund (ETF): What It Is, How to Invest

What Is an Exchange-Traded Fund (ETF)?

By Anders Bylund – Updated Jul 1, 2025 at 3:40 AM EST

Key Points

ETFs combine the easy trading of stocks with the diversification of mutual funds.
Most ETFs passively track indexes, offering lower fees and predictable performance.
They're traded on exchanges, allowing instant buy/sell like stocks.

Stocks are easy to trade but only give you ownership in one company. Mutual funds provide diversification and flexibility with professionally managed portfolios but are saddled with clumsier trading processes and potentially higher tax bills.

An exchange-traded fund (ETF) delivers the best of both worlds. With ETFs, you get access to large, diversified stock portfolios through a single ticker that behaves like a simple stock in many ways.

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An infographic defining and explaining the term exchange-traded fund (ETF). — Image source: The Motley Fool.

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Stock Ticker

A shorthand code of letters representing a company's stock for trading purposes, displayed on financial platforms.

ETFs update their prices during each market day, and your order to buy or sell them can be executed right away. This is different from mutual funds, whose share price and transactions are updated only after the closing bell.

So, you probably know the drill already: Open and fund a brokerage account (if you didn't already have that essential puzzle piece), research your options, and pick the best ETF for your purposes. At this point, you're almost done. Set your budget for this ETF investment, figure out how many shares you can buy for that amount, and place your order. Before you know it, the targeted ETF will be part of your portfolio.

The job doesn't end there, of course. Just like any stock, you should keep an eye on your ETF and be ready to take action if your investment thesis changes.

FAQ about exchange-traded funds

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About the Author

Anders Bylund is a contributing Motley Fool media and technology analyst covering semiconductors, cloud computing, internet infrastructure, quantum computing, and streaming media. Previously, Anders was a systems administrator for Nielsen Technology and CSX, gaining hands-on experience with enterprise-class systems. He was also a freelance writer for Ars Technica, TIME, USA Today, CNN, WIRED, and AOL's Daily Finance. He holds a bachelor’s degree in English and a master’s degree in library and information sciences from Florida State University. He believes in coyotes and time as an abstract.

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Charles Schwab is an advertising partner of Motley Fool Money. Anders Bylund has positions in Vanguard S&P 500 ETF. The Motley Fool has positions in and recommends Berkshire Hathaway and Vanguard S&P 500 ETF. The Motley Fool recommends Charles Schwab and recommends the following options: short June 2025 $85 calls on Charles Schwab. The Motley Fool has a disclosure policy.