Exchange-traded fund (ETF)
Also known as: ETF, exchange traded fund
An exchange-traded fund (ETF) is a pooled investment fund whose shares trade on stock exchanges throughout the day like a stock, typically tracking an index at low cost.
An exchange-traded fund (ETF) is a pooled investment vehicle whose shares trade on an exchange just like individual stocks. Most ETFs are passively managed, built to track a benchmark such as the S&P 500, though actively managed ETFs also exist. An investor who buys one share of an S&P 500 ETF instantly owns a small slice of a diversified portfolio of 500 companies.
The defining feature is intraday tradability. Mutual fund orders are all filled once per day at the fund's next-computed NAV, but ETF shares are bought and sold continuously at market prices whenever the exchange is open. That also means ETF shares can be sold short, bought on margin, and traded with limit orders — none of which is possible with mutual fund shares. A creation-and-redemption mechanism involving large institutional participants keeps an ETF's market price close to the value of its underlying holdings.
ETFs are popular because they combine diversification with low costs and tax efficiency. Passive ETFs typically charge lower expense ratios than actively managed funds, and their structure tends to generate fewer taxable capital gains distributions than a comparable mutual fund. Investors pay a brokerage commission or spread to trade, rather than a sales load.
The SIE, Series 7, Series 65, and Series 66 exams all test ETFs, usually by contrasting them with mutual funds: exchange trading versus forward pricing, margin and short-sale eligibility, low expenses, and the risks of specialized products such as leveraged and inverse ETFs, which are designed to hit their multiple on a daily basis only.
Key takeaways
- ETFs are pooled funds whose shares trade intraday on exchanges at market prices.
- Unlike mutual funds, ETF shares can be sold short, purchased on margin, and traded with limit orders.
- Most ETFs passively track an index, keeping expense ratios and taxable distributions low.
- Leveraged and inverse ETFs reset daily and are generally unsuitable for long-term buy-and-hold investors.
- Securities exams test ETFs primarily by contrast with open-end mutual funds.