Money Basics: What's an ETF?
ETFs, or exchange traded funds, are funds that own assets like stocks, bonds, commodities or foreign currencies. The value of the assets is spread among the investors who own the ETF. Shareholders do not directly own or have any direct claim to the underlying investments in the fund; rather they indirectly own these assets. Unlike mutual funds, however, ETFs trade like stocks on an exchange.
ETFs can track broad market indexes like the Nasdaq Composite or the Dow Jones Industrial Average. However, they typically don’t actually own every security in those indexes. For example, an ETF tracking the S&P 500 index will not hold the same 500 stocks as the index, but it will hold securities that closely track the index’s performance. Because it can track an index and own a variety of different assets, an ETF can be a good way to diversify a portfolio. That diversification also reduces the risk of losing large amounts of money on an ETF.
There are a few ways to make money from investing in ETFs. For example, ETFs that own dividend-paying stocks will also pay out a dividend. They also trade like stocks, so you can sell your stake in an ETF for a profit if the value rises. Note that ETFs typically have fees attached to them, but they are generally (though not always) less than many mutual funds. ETFs can be a great addition to a portfolio, but as with any investment, it’s best to read up on the risks before committing money to them.
ETFs are not risk-free. If the value of an ETF drops, investors lose money. If demand for a particular ETF drops, it could be dissolved altogether. In that scenario, investors will usually get a 30-day notice that the ETF is closing, giving them some time to sell and invest in other ways. If an investor sticks with the ETF to the bitter end, they’ll receive the cash value of the liquidation, which, depending on the ETF itself, may or may not be less money than the initial investment.
