An Exchange Traded Fund or ETF is an investment fund

that trades like a stock.

ETFs, like other types of funds, pull together

money from investors into a basket

of different investments, including stocks, bonds,

and other securities.

By spreading the fund's money into different securities,

ETFs can generally provide investors with diversification,

which can help balance risk.

And because ETF shares are traded on a stock exchange,

they're bought and sold like stocks

and usually incur commissions and other related fees.

Just like there are a variety of mutual funds,

there are a variety of different ETFs,

each with different objectives.

Some ETFs invest in a variety of stocks and bonds.

Some replicate the performance of a stock index,

like the Dow Jones Industrial Average or S&P 500,

and others tracked the performance

for a particular market sector, like technology

or pharmaceuticals.

However, different ETFs offer different amounts

of diversification.

For example, ETFs that focus more on specific sectors

typically offer less diversification

than those that are designed to replicate an index.

Let's look at an example of investing in an ETF.

Suppose an investor wants to make a diversified investment

that is designed to mirror the performance of a major stock

index like the S&P 500.

After researching different ETFs and finding

the one he wants based on his objective,

he purchases shares of it through his broker,

just like he would an individual stock.

Now that he owns shares, the investor

has a stake in each of the fund's basket of investments,

while only having to purchase one ETF.

Participating in the wide market with only a single purchase

instead of multiple purchases can save an investor research

and analysis time.

So how can an investor potentially achieve

a positive return from the ETF?

Similar to a stock, he can earn a return two ways--

a rising ETF market price and dividends.

Typically, if the value of the ETF's investments increases,

so does its price.

If our investor purchased a hypothetical ETF at $40

and a year later it was selling for $50,

our investor could profit $10 per share

by selling his position.

Of course, if the ETF's price dropped,

our investor would have lost money

if the position was sold at the lower price.

Because many ETFs are traded on a stock exchange,

they can be bought and sold throughout the day.

However, not all ETFs are widely traded,

which can cause difficulty when trying to fill orders.

Now, compare this to a mutual fund.

Most mutual funds are only priced and traded

at the end of the day.

Separate from changes in price, our investor

could potentially gain income if the ETF pays its investors

a dividend, which is a payout of part of the fund's earnings

and capital gains.

Not all ETFs pay dividends.

Many Instead reinvest earnings into the fund's holdings.

One of the ways to tell whether a fund pays dividends

is to look at what's called its dividend yield.

This yield is the amount that the fund pays out

compared to the current market price of a share.

ETFs have other attractive qualities.

While most mutual funds require a minimum investment, which

can be substantial, an ETF investor

can just buy a single share plus any commissions and fees.

Also because most ETFs aren't actively managed,

they typically have lower management fees

than mutual funds.

There is a wide variety of ETFs that attempt to track assets,

like corporate bonds, stocks in remote countries,

commodities, and even currencies among many other investments.

While these assets carry unique risks, the ETFs that track them

offer investors a practical way to analyze

and potentially find opportunities

in a number of markets.

Want to learn more about ETFs and other investments?

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