# What Is an ETF?

> An ETF is a fund that trades on an exchange like a stock. Learn how ETFs track an index, how they differ from mutual funds, their costs and how to choose one.

Source: https://learn.tradelabsai.com/markets/what-is-an-etf/  
Track: Markets and Instruments · Level: Beginner · Updated: 2026-10-03  
Publisher: TradeLabs AI (https://tradelabsai.com). Education, not financial advice.  
Cite as: TradeLabs Learn, "What Is an ETF?", https://learn.tradelabsai.com/markets/what-is-an-etf/

An exchange traded fund, or ETF, is a basket of investments that trades on a stock exchange as a single share. Buying one share of an S&P 500 ETF gives you a small slice of all 500 companies in that index. ETFs combine the diversification of a fund with the convenience of a stock: you can buy or sell them any time the market is open, at a live price.

## How an ETF works

An ETF company creates a fund that holds a portfolio, usually designed to track an [[what-is-an-index|index]]. The fund is divided into shares that trade on an exchange. Their price stays close to the value of the underlying holdings, called the net asset value or NAV, through a mechanism involving large trading firms known as authorised participants.

**Note: How the price stays close to the holdings**
If an ETF's share price rises above the value of its holdings, authorised participants can buy the underlying stocks, hand them to the fund in exchange for new ETF shares and sell those shares at the higher price. That extra selling pushes the price back down. The reverse happens when the ETF trades below its holdings. This creation and redemption process keeps most large ETFs within a few cents of their NAV.

The first US ETF, the SPDR S&P 500 ETF Trust (ticker SPY), launched in 1993 and is still one of the most traded securities in the world.

## Types of ETFs

| Type | Holds | Example use |
|---|---|---|
| Broad stock index | Hundreds or thousands of stocks | Core long term holding |
| Sector | Stocks in one industry | Trading a view on technology or energy |
| Bond | Government or corporate bonds | Income, lower volatility |
| Commodity | Gold, oil futures or similar | Exposure without futures accounts |
| Country or region | Stocks from one area | International exposure |
| Leveraged and inverse | Derivatives aiming for 2x, 3x or minus 1x daily returns | Very short term trading |
| Thematic and active | Chosen stocks around a theme or a manager's picks | Specific ideas |

**Watch out: Leveraged ETFs reset every day**
A 2x leveraged ETF aims for twice the index's return over one day, not over weeks or months. In choppy markets, daily resetting can cause it to lose value even if the index ends flat. These products are designed for short term trading, not holding.

## ETFs vs mutual funds

| | ETF | Mutual fund |
|---|---|---|
| How you trade | On an exchange, any time during market hours | Directly with the fund company |
| Price | Live market price | Once a day, at the closing NAV |
| Minimum | One share, or a fraction at some brokers | Often a set minimum investment |
| Costs | Usually low expense ratio plus a small spread | Varies; some charge sales loads |
| Tax efficiency (US) | Usually higher, due to creation and redemption | Often distributes more taxable gains |

For most index investors, both can work. ETFs suit traders better because of intraday pricing, the ability to use limit and stop orders and, for popular funds, very tight [[bid-ask-spread|spreads]].

## What ETFs cost

- **Expense ratio:** a yearly fee taken from the fund's assets. Broad index ETFs can cost well under 0.1% a year; specialised ETFs often cost more.
- **Spread:** the gap between bid and ask when you trade. Large ETFs often trade one cent wide; small ones can be much wider.
- **Tracking difference:** how far the fund's return differs from its index over time, from fees and trading costs.

**Example: What a fee costs over time**
$10,000 invested for 20 years at a 7% yearly return grows to about $38,700 before fees. With a 0.05% expense ratio it ends around $38,300; with 1.00% it ends around $32,100. The higher fee costs more than $6,000.

## How to choose an ETF

1. **Know what it holds.** Read the fund's index and top holdings, not just its name.
2. **Check the expense ratio** and compare with similar funds.
3. **Check liquidity:** average daily volume, assets under management and typical spread.
4. **Understand the structure:** leveraged, inverse and futures based funds behave differently from simple stock funds.
5. **Look at tracking:** how closely past returns matched the index.

## Frequently asked questions

### Are ETFs good for beginners?

Broad, low cost index ETFs are one of the simplest ways for beginners to invest in many companies at once. Leveraged and complex ETFs are not beginner products.

### Can an ETF go to zero?

A broad index ETF would only go to zero if every company in it became worthless, which is extremely unlikely. Narrow, leveraged or inverse ETFs can lose most of their value.

### Do ETFs pay dividends?

Many do. ETFs holding dividend paying stocks or interest paying bonds usually pass that income to shareholders, often quarterly or monthly.

## Sources

- U.S. Securities and Exchange Commission, [Exchange traded funds](https://www.investor.gov/introduction-investing/investing-basics/investment-products/mutual-funds-and-exchange-traded-1)
- Wikipedia, [Exchange traded fund](https://en.wikipedia.org/wiki/Exchange-traded_fund)

## Continue learning

- Next lesson: [What Is an Index?](https://learn.tradelabsai.com/markets/what-is-an-index/)
- Previous lesson: [What Is a Bond?](https://learn.tradelabsai.com/markets/what-is-a-bond/)
- Related: [What Is a Bond?](https://learn.tradelabsai.com/markets/what-is-a-bond/): A bond is a loan you make to a government or company in return for interest. Learn coupons, face value, yield, why bond prices fall when rates rise and the risks.
- Related: [What Is an Index?](https://learn.tradelabsai.com/markets/what-is-an-index/): A market index tracks a group of assets with one number. Learn how indexes like the S&P 500 and Dow are built, weighting methods and how traders use them.
- Related: [ETF Trading](https://learn.tradelabsai.com/markets/etf-trading/): How to trade ETFs: choosing liquid funds, order types, spreads and premiums, sector and leveraged ETFs, and the strategies traders use with ETFs.
- Related: [What Is a Stock?](https://learn.tradelabsai.com/markets/what-is-a-stock/): A stock is a share of ownership in a company. Learn what owning a share gives you, why stock prices move, common vs preferred shares and how to trade them.
- Related: [Index Trading](https://learn.tradelabsai.com/markets/index-trading/): How to trade stock market indexes using ETFs, futures, options and CFDs, what moves indexes, the best times to trade them and how to manage the risk.
- Related: [Diversification](https://learn.tradelabsai.com/portfolio/diversification/): Diversification lowers risk by combining assets that do not move together. Learn the maths, how many holdings you need, its limits in crises and common mistakes.