4 Quick Facts That Simplify ETFs (Exchange-Traded Funds)

ETFs are investment securities you should know about and understand

Tunji Onigbanjo


ETF on Blackboard by Marco Verch

An ETF, exchange-traded fund, is a security that trades on stock exchanges and tracks an underlying basket of securities, such as stocks, bonds, or commodities. Most ETFs track an index, such as a stock index like the S&P 500 Index or a bond index like the Bloomberg Barclays Aggregate Index. ETFs allow you to easily buy and sell a basket of securities without having to buy each of the securities individually. The first major ETF was launched in 1993. Today, the United States ETF industry has over $4 trillion of assets under management. For a brief history of ETFs, you can check out this article. ETFs can be slightly confusing to a person new to them, but once you understand the 4 quick facts below, you will be able to better understand the industry and ETFs in general.

Disclaimer: I am not a financial advisor. I do not know your financial situation. I am purely sharing the information I have learned for educational purposes.

1. Buying a Share of an ETF Is Buying a Share of the Basket It Tracks

When you buy a share of an ETF, you are not buying each component that the ETF consists of. You are buying a share of that basket. Buying a share of the basket allows you to reap the benefits of being diversified. Diversification is a risk management strategy. Being able to buy a share of a basket of stocks instantly such as the $SPY, which is the SPDR S&P 500 ETF Trust, is less risky than buying a share of an individual company. To be able to gain the diversification levels that an ETF offers, it would take a lot of money and effort on your part. For example, a share of an ETF such as $SPY can be $250 while a share of a single company such as Amazon can be $2,000. In this example, if you wanted to buy a share of Amazon, you would need $2,000, but if you wanted to gain exposure to Amazon, which is a component of $SPY that makes up around 4% of its basket, you will just need $250. In addition to the diversification benefits from ETFs, you also have access to transparency for ETFs. ETF holdings are disclosed daily to the public. You can use websites such as Zacks or ETFDB to see all the holdings of an ETF.

2. Buying an ETF