ETF Education

What is an ETF?

An exchange traded fund (ETF) is a bundle of investments, such as shares and bonds, that you can buy and sell in a single trade on an exchange.
ETFs are commonly used to spread risk and to track broad markets in a single investment. Like all investments, they carry risks.
ETFs have grown significantly in popularity since they first launched more than 30 years ago.

5 min read

Marketing Communication. The value of your investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

An exchange traded fund (ETF) is a basket of investments (like shares, bonds, currencies, or commodities) that you can buy and sell in a single trade. Some ETFs give you a stake in hundreds or even thousands of investments at once, often by tracking a major index. Others focus on a narrower market, sector, or theme. Active ETFs are managed by professionals aiming to meet a particular investment objective, rather than passively tracking an index.

There are more than 14,000 ETFs worldwide,¹ letting people invest in everything from broad-market indexes to specialised market segments. Buying an ETF is a bit like walking into a grocery store and choosing between several carts that are already filled with items from the shelves. Some carts are filled with weekly staples like bread, milk, and eggs, while others are filled with organic produce, international foods, or specialty ingredients. In the same way, different ETFs provide exposure to different mixes of investments.

ETFs trade on an exchange just like shares, so they can be bought and sold throughout the day. And because an ETF holds a basket of investments, its price is closely tied to what those investments are worth. Behind the scenes, certain large financial institutions, known as authorised participants, can create new ETF shares or remove existing ones from the market when needed. This process helps keep the ETF’s price in line with the value of the investments it holds, even as investor demand changes.

Types of ETFs

There’s an aisle for just about anything you could need at the grocery store. Similarly, ETFs cover a wide range of markets, asset classes, and strategies. Here are the most common categories:

Broad equity ETFs: Track broad equity indices (like the MSCI World Index) to gain exposure to hundreds of companies.
Bond ETFs: Focus on fixed income securities like government bonds and corporate bonds.
International ETFs: Access markets in different regions, including developed and emerging markets.
Sector ETFs: Target specific sectors of the economy, like technology, health care, or energy.
Thematic ETFs: Invest in overarching trends, such as artificial intelligence, clean energy, or demographic changes.
Dividend ETFs: Hold companies that pay dividends—though income is not guaranteed and treatment depends on ETF structure and local tax rules.
Commodity ETFs: Provide exposure to assets like gold, oil, agriculture, or a broad-basket of commodities.
Active ETFs: Invest in funds managed by professionals who aim to achieve specific investment objectives, rather than passively tracking an index.

Why investors use ETFs

Investors use ETFs for a number of reasons, although the features, costs, and risks vary from fund to fund.

Diversification

A broadly diversified ETF may hold hundreds or even thousands of underlying investments, potentially reducing reliance on the performance of any one holding. More focused ETFs may be considerably less diversified.

Access

ETFs often allow you to invest in a specific segment of the market. In addition to different asset classes, geographies, and sectors, ETFs may provide access to different currencies, like the Japanese yen or Chinese yuan, or investment themes, like sustainability, cybersecurity, or autonomous vehicles.

Lower costs

Because many ETFs simply track an index, they may have lower ongoing charges than many investment funds actively managed by a fund manager who chooses the investments. Costs vary by ETF, and investors should also consider trading costs and platform fees.

Flexibility

ETFs can generally be bought and sold through brokers or investment platforms during exchange trading hours. Note that liquidity can vary by ETF and market conditions.

Transparency

Many ETFs disclose their holdings regularly, often daily. That transparency can help you better understand the investments you hold.

ETF risks

Like any investment, ETFs involve risk. The value of an ETF can go down as well as up. As with any investment, it’s important to understand the risks of ETFs before adding them to a portfolio:

Market risk: The value of an ETF may fall if the market or assets it holds decline.
Concentration risk: ETFs focused on one sector, country, or theme may be more exposed to developments affecting that area.
Currency risk: Returns may be affected by exchange-rate movements when the ETF or its holdings are denominated in another currency.
Liquidity risk: It may be more difficult or expensive to buy or sell an ETF in some market conditions.
Tracking difference: An index-tracking ETF may not match its index exactly because of costs and other factors.

Before buying an ETF, you can review the fund's objectives, risks, charges, and key documents, including the Key Information Document (KID), and, where available, the prospectus.

ETFs vs shares vs traditional investment funds

It can be helpful to compare three main ways of investing in the stock market: individual shares, traditional investment funds, and ETFs. Different investment vehicles work in different ways, with different risks, costs, and trading features

Shares give you part ownership of a particular company, which may appeal to investors seeking exposure to specific businesses.
Traditional investment funds may track a market or follow an active strategy. Unlike ETFs, they are generally bought or sold at a price calculated once a day.
ETFs are baskets of investments you can buy or sell throughout the day, in a single trade.

How to buy an ETF

ETFs are typically bought through a broker, bank, or investment platform. Platform access, account types, fees, and order types vary by country and provider.

Tax treatment also varies from investor to investor, depending on things like where you live, where the ETF is based, how you hold it, and whether it pays out income or reinvests it. It's worth understanding how a particular ETF would be taxed in your situation before you invest.

Frequently asked questions

What is the main purpose of an ETF?

Why do some beginner investors use ETFs?

Do ETFs pay income?

Glossary

Active and passive management

A passive (or index) fund aims to track the performance of a market index. An active fund is run by a manager who chooses the investments in pursuit of a particular objective.

Asset class

A broad type of investment with similar characteristics, such as company shares (equities), bonds (fixed income), or commodities. Different asset classes can behave differently under the same market conditions.

Authorised participant

A large financial institution that can create new ETF shares or remove existing ones from the market, helping ETFs trade smoothly.

Bond

A type of investment that represents a loan to a government or company. In return, the issuer typically pays interest and aims to repay the original amount at maturity.

Distributing and accumulating share classes

Two versions of the same fund. A distributing share class pays income out to you; an accumulating share class reinvests that income inside the fund instead.

Diversification

Spreading investments across many holdings, sectors, or asset classes to reduce reliance on any single one. Diversification does not remove risk or prevent losses.

Dividend

A payment a company can make to its shareholders out of its profits. Dividends are not guaranteed and can change or stop.

ETF (exchange traded fund)

An investment fund that holds a basket of investments, such as shares or bonds, and trades on a stock exchange like a share. Many ETFs track an index; others are actively managed.

Exchange

A regulated marketplace where investments such as shares and ETFs are bought and sold.

Index

A group of investments used to measure the performance of part of a market. For example, an index might track large European companies or global shares.

Key Information Document (KID)

A short, standardised document giving retail investors the essential facts about an investment, including its risks and costs.

Liquidity

How easily an investment can be bought or sold without significantly affecting its price. Liquidity can vary with the ETF, its underlying holdings, and market conditions.

Ongoing charges

The yearly cost of running an ETF, shown as a percentage of the fund's value. This typically does not include trading costs or platform fees.

Prospectus

A detailed document that sets out an investment fund's objectives, risks, charges, and how it works.

Share

A unit of ownership in a company. When you buy an ETF, you buy shares in the fund, which in turn holds investments such as company shares or bonds.

Tracking difference

For an index ETF, the gap between the fund's return and the return of the index it tracks over a period. Funds usually fall slightly short of the index, mainly because of costs.

Traditional investment fund

An investment fund that pools money from many investors to buy a portfolio of investments. Unlike an ETF, it is usually bought or sold at a single price calculated once a day, rather than traded on an exchange.

Footnotes

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Important Information

Investing involves risk including the risk of loss of principal.

The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without State Street Investment Management’s express written consent.

All information is from State Street Investment Management unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.

Equity securities may fluctuate in value and can decline significantly in response to the activities of individual companies and general market and economic conditions.

Bonds generally present less short-term risk and volatility than stocks, but contain interest rate risk (as interest rates rise, bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.

Currency Risk is a form of risk that arises from the change in price of one currency against another. Whenever investors or companies have assets or business operations across national borders, they face currency risk if their positions are not hedged.

Diversification does not ensure a profit or guarantee against loss.

There can be no assurance that a liquid market will be maintained for ETF shares.

Frequent trading of ETFs could significantly increase commissions and other costs such that they may offset any savings from low fees or costs.

The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor.