Investing 101: What Is an ETF?

If you're looking for an asset that's as flexible as a stock with the diversity of an index mutual fund, the best investment option for you might be an exchange-traded fund.

A Relative Newcomer to the Market

The first ETFs were created in 1993, but they didn't become popular until the early 2000s. ETFs track stock indexes, specific commodities, or other baskets of assets. So when you buy a share of an ETF, you're investing in a (usually) diversified portfolio that tracks a particular commodity, industry or market, without dealing with the high costs and strict laws that are involved with buying all the individual assets separately.

ETFs are flexible (significantly more so than mutual funds), have low fees, and offer investors the option of owning as many or as few shares as they like, while still allowing access to a good chunk of the market. You can buy as little as one share of an exchange-traded fund, whereas other fund options require a significantly higher minimum investment.

The Best of Both Worlds

In some ways, ETFs look like mutual funds. But, like stocks, they're extremely flexible. They combine some of the best things about both types of investments in one convenient package.

%VIRTUAL-WSSCourseInline-449%ETFs are similar to index funds in that they attempt to replicate the performance of a segment of the market. The goal of an ETF isn't to "beat the market," but to mimic the yields and returns of the index or assets it tracks. They're a great way to diversify a portfolio, and an especially good choice if you favor a "passive management" approach.

It's easy to trade an ETF: Like stocks, you can buy and sell them at any time during market hours on an open exchange. Prices are constantly updated throughout the day, so you have the option of trying to sell short or on margin. That's not possible with mutual funds, which are priced once a day, at the close of trading.

In addition to offering some of the best features of stocks and index funds, ETFs are also great for tax-savvy investors. They're low-fee investments, and investors usually aren't taxed on their gains until they're sold. Thanks to their structure, the capital gains tax hit you'll take on an ETF is often less than it would be with a similarly targeted mutual fund.

A Great Option for Average Investors

To sum up, ETFs offer a cheap and easy way to invest in sectors of the market that might otherwise be inaccessible to retail investors because of their high costs, or because they require specialized knowledge to get started. That makes them a great way for an average person to get into the market -- and explains their ever-growing popularity.