How ETFs Work: A Simple Guide

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Exchange-traded funds have taken the investing world by storm. But many people don't know how they work. What's behind the most popular ETFs in the market?

In the following video, Dan Caplinger, The Motley Fool's director of investment planning, looks at ETFs and how they work. Dan notes that ETFs are very like mutual funds, helping you diversify your portfolio even with small amounts to invest. Unlike mutual funds, though, ETFs let you buy and sell shares throughout the day. Dan points out that unlike with mutual funds, ETFs involve buy shares on the open market, which in turn are controlled by authorized participants that create and redeem large blocks of shares. With equity ETFs, those actions involve stocks or cash; with bullion ETFs iShares Silver and SPDR Gold , authorized participants use bullion to create or redeem ETF shares.

Dan points out that this mechanism makes it impossible to guarantee that ETFs trade at their net asset value. He concludes that sticking with liquid ETFs like SPDR S&P 500 and Vanguard Total Stock Market ETF  is the best way to get fair value.

How ETFs can help you the most
Whether you buy ETFs or individual stocks, getting into the market is a critical part of ensuring that your financial future will be a prosperous one. In our brand-new special report, "Your Essential Guide to Start Investing Today," The Motley Fool's personal finance experts show you why investing is so important and what you need to do to get started. Click here to get your copy today -- it's absolutely free.

The article How ETFs Work: A Simple Guide originally appeared on

Fool contributor Dan Caplinger and The Motley Fool have no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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