What is an ETF?
An ETF, or exchange-traded fund, is a type of investment fund that holds a collection of assets such as stocks, bonds, commodities, or a combination of these, and can be traded on stock exchanges like individual stocks. ETFs offer investors a way to diversify their portfolios and gain exposure to a particular market or sector with a single purchase. They also tend to have lower expense ratios than actively managed funds.
How do ETFs work?
ETFs work by holding a basket of assets, such as stocks, bonds, commodities, or a combination of these, and can be bought and sold on stock exchanges like individual stocks. They are designed to track the performance of a particular market index, such as the S&P 500, or a specific sector, such as technology or healthcare.
When an investor wants to buy shares of an ETF, they can do so through a brokerage account, just like buying any other stock. The ETF's price will fluctuate during the day based on supply and demand, just like any other stock. When an investor wants to sell their shares, they can do so by placing a sell order through their brokerage account, again just like any other stock.
The ETF provider, also known as the issuer, creates and redeems shares of the ETF based on the demand from investors. When an investor wants to buy shares of an ETF, the issuer will create new shares and sell them to the investor. When an investor wants to sell shares, the issuer will redeem the shares and return the underlying assets to the ETF.
The underlying assets that the ETF holds, such as stocks or bonds, are chosen and managed by the ETF issuer to align with the performance of the index or sector the ETF is designed to track. Additionally, the ETF issuer will also manage the ETF's expense ratio, which is the fee charged to cover the ETF's operational expenses.