Skip to content
  • AboutExpand
    • Contact
    • Press
    • The Women Who Money Team
    • Sponsor WwM
  • Estate Planning 101 Book
  • ArticlesExpand
    • 100-Level (Novice)
    • 200-Level (Intermediate)
    • 300-Level (Advanced)
    • Reviews – Books, Apps, Tech, ProductsExpand
      • Book Reviews
    • Inspiring Money Interviews
    • Reader’s Stories
Women Who Money Logo
  • Glossary
  • Recommended
  • DirectoriesExpand
    • Personal Finance Blogs by Women
    • Personal Finance Professionals
    • Female Hosted/Co-Hosted Personal Finance Podcasts
  • Start HereExpand
    • Ready to Learn More About Managing Your Money? Start Here
    • Have Important Questions About Your Career? Start Here
    • Have Questions About Your Kids and Money? Start Here
    • Questions On Housing – Buy, Rent, Sell, Move? Start Here
    • Ready to Learn About Investing In Real Estate? Start Here
    • Have Questions About Estate Planning? Start Here
  • EarningExpand
    • Career
  • Investing
  • Saving
  • PlanningExpand
    • College
    • Estate Planning
    • Health Care
    • Insurance
    • Retirement Planning
  • Credit & Debt
  • Everyday $Expand
    • Charity
    • Housing
    • Travel
  • Relationships & MoneyExpand
    • Marriage and Money
    • Kids & Money
  • Entrepreneurship
Women Who Money Logo
Home / Invest Money / What are Exchange Traded Funds (ETFs)?

What are Exchange Traded Funds (ETFs)?

200-Level (Intermediate) | Invest Money
UpdatedMarch 28, 2022

(This page may contain affiliate links and we may earn fees from qualifying purchases at no additional cost to you. See our Disclosure for more info.)

 

Investing in the stock market can be an excellent way to build long-term wealth. There are many different ways to invest, depending on your financial goals and risk tolerance.

Creating a diversified investment portfolio is one of the best ways to grow your money.

Diversification helps you build wealth while lowering the risk of having all your eggs in one basket.

When deciding how to diversify your portfolio, you might consider Exchange Traded Funds (ETFs).

First introduced in 1993, they're relatively new. Yet, ETFs have become a popular and useful investing tool for financial professionals and individuals alike.

Below we’ll cover the basics of exchange-traded funds to help you decide if they’re a valuable investment you can use to build wealth.

etf bonds and stock tags on table with rolls of money

What are Exchange Traded Funds (ETFs)?

An Exchange Traded Fund (ETF) is a grouping of stocks, bonds, and other assets combined into one investment fund.

Each share of an ETF represents equal parts of the holdings within the fund.

ETF shares are bought and sold through a broker and most track stock market indexes. In this respect, they are much like mutual funds.

What makes ETFs unique is that their shares trade on stock exchanges throughout the day.

How do they work?

Exchange-traded funds are baskets of stocks, bonds, commodities, or a mix of all of them, based on a market index or sector.

Large financial companies, like Vanguard and Fidelity, create and administer ETFs. But to create an ETF, they must take specific actions before selling the ETF shares to investors.

How Exchange Traded Funds (ETFs) get Created:

1. A financial company determines the combination of assets to include in an ETF (for example, what market index to track).

2. The company submits the plan for the ETF to the Securities and Exchange Commission for approval.

3. Once approved, the fund's assigned Authorized Participants (APs), or market makers, buy the fund's basket of assets.

4. The ETF is assigned a ticker symbol and divided into shares.

5. Shares get sold to individual investors.

Shares of an ETF represent the fund's assets.

The fund itself owns the underlying assets – and the investors own shares of the ETF. Most ETFs do an excellent job of tracking the underlying assets.

Fund holdings get adjusted regularly to coincide with the assets’ market value. And prices of ETF shares change throughout each day as the market fluctuates.

For example, let's say you buy shares of a stock ETF that tracks the S&P 500. When the S&P 500 goes up, your ETF will increase in value, and vice versa.

Types of ETFs

There are many types of ETFs. No matter what your investing goal is, you can find an ETF that will suit your purpose.

You can find stock and bond ETFs, or ETFs for precious metals, and even real estate ETFs, to name a few.

Common types of ETFs:

  • Stock ETFs allow for more diversification and carry less risk than investing in individual stocks. But, by nature, stocks are volatile, and any stock ETF carries some risk. Stock ETFs are best held long-term and balanced with other less risky funds.
  • Bond ETFs contain any combination of different types of bonds. Unlike individual bonds, bond ETFs don’t have a maturity date. They often pay regular interest payments to the investor.
  • Commodity ETFs. Commodity ETFs are a basket of commodities. They include physical goods, like precious metals, agricultural products, and other raw materials.
  • International ETFs are a way for investors to diversify international investing.
  • Dividend ETFs contain dividend-paying stocks. Many investors choose this type of ETF to receive income payments.
  • Sector ETFs represent stocks from a particular sector of the market, such as finance, tech, health care, or other industries.
  • Leveraged ETFs, as their title suggests, use debt to invest for the potential of better returns. But investors should use extreme caution and think twice about the risk of investing in this type of ETF.

What are their benefits?

1. Low cost.

Since ETFs track indexes, they're passively managed. They often have lower expense ratios than many of their mutual fund counterparts.

Investing in ETFs is cheaper than trading stocks too.

That said, there are trade fees when you buy or sell ETF shares. And, if you trade often, your expenses will add up and cut into your returns.

The best way to keep costs low is to buy and hold long-term.

2. Variety and flexibility.

With hundreds of ETFs in existence, there’s something for everyone. Investors have access to a wide range of investment types and market sectors.

3. You don’t need a lot of money to invest in ETFs.

There's no set minimum requirement for investing in ETFs, as there is for many mutual funds.

The cost of investing in ETFs is the share price, so new investors can start investing with less money.

4. Diversification.

ETFs that track indexes are more diversified than individual stocks, bonds, or other assets. They help spread out risk since they contain a combination of many different assets.

Some ETFs contain large numbers of stocks or other assets. In contrast, others are more focused on a specific sector and hold fewer assets.

It’s wise to research an ETF’s diversification before investing.

Since ETFs publish their holdings each day, it’s easy for individual investors to see if the asset allocation and holdings fit their money goals.

5. Tax efficiency.

ETFs are structured so the creation and redemption of shares within the fund (by the Authorized Participants) are not considered taxable.

Capital gains taxes aren’t paid on an ETF until the fund is redeemed, or when the investor receives dividend or interest payments.*

*There are exceptions with certain types of ETFs, including precious metals, currency, and futures.

6. Liquidity.

Most ETFs are liquid, as they can be bought and sold throughout the day, like stocks.

Still it’s worth mentioning that some of the less frequently traded ETFs might be harder to sell.

What are their disadvantages?

1. No option to reinvest dividends (No DRIPS).

Some ETFs contain dividend-paying stock, but there's no option to reinvest them automatically.

Dividends are paid directly to ETF investors.

2. Trading fees.

When you buy or sell shares of an ETF, you pay brokerage commission fees. But some brokers waive these fees.

Check with your broker for more information on ETF fees.

3. Actively managed ETFs cost more.

Though most ETFs are passively managed, there are exceptions.

4. Diversification is limited in ETFs with targeted fund groups.

Most ETFs track market indexes and consist of a basket of assets that diversify the fund. But some ETFs focus on specific investments and have less variety.

For example, some ETFs might invest only in precious metals – limiting diversification and increasing investor risk.

5. Some ETFs have higher tax rates.

For example, precious metals get taxed at the “collectible” tax rate, a much higher rate than other ETFs.

Are ETFs Useful for You?

ETFs appeal to many individuals because of their variety, flexibility, and low costs.

Yet it’s wise to do your research on any investment to make sure it fits with your investing goals.

You might find ETFs useful if you:

  • Are a long-term investor and plan to buy and hold investment
  • Want to invest in specific sectors of the stock market – but you don’t want to sort through individual investment options
  • Like the liquidity offered by ETFs (compared to mutual funds)
  • Want to keep expense ratios and other investment-related costs low
  • Don’t have a lot of money to invest, but want to get started and diversify
  • Want to customize your portfolio without buying individual stocks, bonds, or commodities

How to Invest in Exchange Traded Funds

You can buy and sell ETFs through brokerage firms, including online brokers and robo-advisors.

Before investing in an ETF, answer these questions:

  • What market index does the fund track?
  • What are the fund’s holdings and asset allocation?
  • How is it managed?
  • How long has it been around?
  • Does the diversification of the fund match my risk tolerance?
  • Do I understand how this ETF works?

Closing Thoughts

Exchange-traded funds are another excellent investment option to consider as part of your overall financial plan.

They allow you to customize your investments and diversify your portfolio.

They're different from other investments, like stocks and mutual funds. And it’s essential to understand these differences.

But once you know the basics of ETFs, you can determine if they make sense for you!

Further Reading:

  • What Does it Take to be a Successful Investor?
  • Is Real Estate Investing a Good Way to Build Wealth?
Amanda Headshot

Article written by Amanda, a team member of Women Who Money and the founder and blogger behind Why We Money where she enjoys writing about happiness, values, and personal finances.

personal capital graphicpersonal capital graphic
Women Who Money

Amy Blacklock and Vicki Cook co-founded Women Who Money in March 2018 to provide helpful information on personal finance, career, and entrepreneurial topics so you can confidently manage your money, grow your net worth, improve your overall financial health, and eventually achieve financial independence.

Facebook Twitter Instagram Linkedin
Hello & Welcome to WwM!

We're here to help you learn more about managing your money, so you can reach your financial goals.

Let's improve your financial health, grow your net worth, and achieve financial independence!

Check Out Our Latest

  • Our Estate Planning Experience [Why we set up a trust]
  • How to Put Together a Benefits Package When You’re Self-Employed
  • Do You Venmo? An easy way to send and receive money
  • Everyone says I need a Roth IRA. Do I really?
  • A Freelance Writer Reflects on Five Years In

Grab Our Book Estate Planning 101 and Learn How to Protect Yourself, Your Loved Ones, and Your Finances

estate-planning-101-book-cover


CIT Bank ad graphic

Women Who Money is a personal finance site dedicated to providing trustworthy financial information.

Our all-female team of money bloggers, authors, and professionals, will help you find answers to all your financial questions and guide you along on your journey to financial independence.

More About WwM

The Women Who Money Team

Our Book Estate Planning 101

Press/Media

Contact Us

Facebook Twitter Instagram Linkedin Medium
  • Home
  • Start Here
  • Credit & Debt
  • Earn Money
  • Save Money
  • Invest Money
  • Everyday Money
  • Charity
  • Planning
  • Relationships & Money
  • Money In Business
  • Reviews
  • Interviews

Pages and articles on this site may contain affiliate links. Please read our Terms & Conditions for more information.

Terms & Conditions

Privacy Policy

We participate in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for us to earn fees, at no additional cost to you, by linking to Amazon.com and affiliated sites.

Copyright © 2018-2023, All Rights Reserved, Women Who Money -  Built with Kadence WP

  • About
  • Our Book
  • Start Here
  • Glossary
  • Trusted Resources
  • Directories
  • Articles
    • Earn
    • Career
    • Saving
    • Invest
    • Credit & Debt
    • Everyday Money
    • Housing
    • Money & Relationships
    • Estate Planning
    • Health Care
    • Insurance
    • Retirement Planning
    • Travel
    • Money & Business
    • Interviews
    • Reviews
Search