What Are Exchange Traded Funds?


Quick Answer

Exchange traded funds, or ETFs, are publicly traded investment funds that attempt to replicate the composition and performance of common indexes, according to Nasdaq. For many investors, owning portfolios that mimic large, diverse indexes such as the S&P 500 or Dow Jones would otherwise be impossible or prohibitively expensive.

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Full Answer

Unlike other investment funds, which actively work to outperform various indexes with complex management strategies, ETFs use passive management strategies that simply involve occasional portfolio rebalancing to reflect index changes and added fund investment, notes Nasdaq. This helps to keep management commissions well below the fees charged on mutual funds and allows investors to retain a greater portion of their investments' earnings. Examples of some of the largest ETFs include the SPDR S&P 500 ETF, which aims to hold investments proportionate to the Standard and Poor's 500 Index, and the Vanguard’s FTSE Emerging Markets Fund, which mimics the Financial Times Stock Exchange index of major Chinese and Taiwanese companies, according to Investopedia.

Some drawbacks of ETFs include the fact that they trail behind actual indexes' returns, due to fees, taxes, exchange rates and other factors, and that they are inflexible when it comes to divesting of poor performing investments that drag down major indexes, states the Globe and Mail. Moreover, ETFs do not allow individuals to make personal choices about index subsets that they might consider to be unethical, such as weapons and fossil fuels companies.

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