What's an ETF - The Ultimate Guide

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Andrew Goldman

Andrew Goldman has been writing for over 20 years and investing for the past 10 years. He currently writes about personal finance and investing for Wealthsimple. Andrew's past work has been published in The New York Times Magazine, Bloomberg Businessweek, New York Magazine and Wired. Television appearances include NBC's Today show as well as Fox News. Andrew holds a Bachelor of Arts (English) from the University of Texas. He and his wife Robin live in Westport, Connecticut with their two boys and a Bedlington terrier. In his spare time, he hosts “The Originals" podcast.

An exchange-traded fund, ETF for short, is an investment fund that lets you buy a large basket of individual stocks or government and corporate bonds in one purchase. Think of ETFs as investment wrappers, like a tortilla that holds together the component ingredients of a burrito, and instead of tomatoes and rice and lettuce and cheese, these burritos were filled with stocks or bonds and are considerably less delicious to eat with salsa. Want to dive in deeper to a specific topic on ETFs? We've got you covered:

You could say that the ETF is a relative of the mutual fund, which is another way to purchase many stocks at one time. But there are a few major differences between ETFs and mutual funds. Whereas mutual funds tend to have human mutual fund managers who actively trade stocks in and out of the fund based on which ones they predict will go up or down, the vast majority of ETFs are unmanaged by humans.

Instead, many ETFs are programmed with an algorithm that simply track an entire economic sector or index, like the S&P 500 or the US bond market. For this reason, mutual funds are generally referred to as being “actively managed” and ETFs “passively managed,” though there are many exceptions to this rule. Unlike mutual funds, which are priced just once a day, ETFs can be bought and sold during the entire trading day just like individual stocks. This explains why they’re called “exchange traded” funds.

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Types of ETFs

Though ETF varieties aren’t nearly as plentiful as grains of sand on the world’s beaches, there are a shocking number and variety of them, possibly even more in number than The Fast And The Furious sequels and spin offs—and their numbers are growing every day. Here are the major asset classes and investment products included in the biggest ETF categories.

Stock Market Tracking ETFs

ETFs that mirror indices like the stock or bond market have attracted by far the most investment from individual investors. Also known as index ETFs or bond ETFs, since they track a particular market index, they're a particularly popular way for investors to own a small stake of the American economy is to invest in ETFs that seek to mirror the S&P 500, an index of the 500 publicly-traded American companies with the highest market capitalizations. Since the S&P 500 or other large indexes like the Dow Jones Industrial Average or the NASDAQ-100 naturally favors the largest companies, those who seek to diversify their equity with smaller companies may consider ETFs that track, say, the S&P 400, or the Russell 2000, which track, respectively, midcap and small-cap publicly traded companies.

Sector Tracking ETFs

Should you want to focus on a particular sector of the economy, rather than the entirety of it, you may want to invest in a sector tracking ETF. Two financial research giants, MSC and Standard & Poor’s (S&P), developed a taxonomy of the global economy that could locate all publicly traded companies in one of 11 main sectors, and dubbed it the Global Industry Classification Standard (GICS).

The sectors in the GICS are as follows:

  1. Communication Services

  2. Consumer Discretionary

  3. Consumer Staples

  4. Energy

  5. Financials

  6. Health Care

  7. Industrials

  8. Information Technology

  9. Materials

  10. Real Estate

  11. Utilities

Not only will you find multiple ETFs tracking each of these sectors, ETFs are now also available tracking the subcategories of each sector, which from largest to smallest are categorized as Industry Group, Industry, and Sub-Industry. So if you specifically want to focus on an area like crude oil companies, there's an ETF for that. MSCI hosts a handy interactive tool that provides an overview of all eleven sectors and their subcategories.

International ETFs

Those who want exposure to international stocks, may choose to invest in one of several types of international ETFs.

ETFs that focus on all economies outside the US.

An ETF like Vanguard’s Total International Stock ETF (VXUS) seeks to “track the performance…of stocks issued by companies located in developed and emerging markets, excluding the United States.” So one price will buy you exposure to most all economies outside of the US. You can also invest in ETFs that track the stock markets of specific countries, like the Toronto Stock Exchange (TSX) or the Tokyo Stock Exchange (TYO).

ETFs that focus on developed markets

Developed markets are the markets of countries that have well established economies, generally an established rule of law and are technologically advanced relative to other countries in the world. A few examples of developed countries are Australia, Japan, and Germany. A developed market ETF would provide broad exposure to all developed markets. BlackRock’s iShares MSCI EAFE ETF (EFA) is a prominent example.

ETFs that focus on emerging markets

The term “emerging markets” was coined in 1981 by economist Antoine van Agtmael when he was working for The World Bank’s International Finance Corporation (IFC) as an alternative to the negative connotations suggested by the term “third world.” Emerging economies like those of Brazil, China, Russia and Turkey are countries with relatively low per capita average salaries that are less politically stable than developed markets but open to international investment. Though investing in emerging markets tends to be riskier than developed ones, the risk is somewhat mitigated when an ETF invests in many, many emerging markets. Vanguard’s FTSE Emerging Markets ETF (VWO), the largest of the type by assets under management (AUM), seeks to “closely track the return of the FTSE Emerging Markets All Cap China A Inclusion Index.”

ETFs that focus on the economy of one country outside the US.

Got a—inexcusably cheesy pun alert—yen to invest in the Japanese economy? BlackRock iShares MSCI Japan ETF (EWJ) promises investors the ability to “access the Japanese stock market in a single trade." There are multiple ways to invest in any economy. And if you ever read up on how difficult it is to buy some foreign stocks, like South Korea’s Samsung, you might decide it’s preferable, and a lot easier to buy, for example a South Korea ETFs, like iShares MSCI South Korea ETF (EWY), which will not only get you a stake in the Galaxy maker, but also a bit of Hyundai motors for diversification’s sake.

Thematic ETFs

If ETFs were a family of mostly strait-laced marketable assets, thematic ETFs would represent the quirky cousin with the handlebar mustache and big parrot on his shoulder. Some of these ETFs seek to either make a statement, by investing only in companies that are environmentally friendly. This is often known as ESG (environmental, social, and corporate governance) investing or socially responsible investing. Others act as financial trend spotters, like the burgeoning high growth marijuana ETFs, created to take financial advantage of the loosening cannabis laws in the US and Canada.

Of course, you should be able to let your financial freak flag fly but be aware that many thematic ETFs are actively managed, and therefore come with considerably higher MERs that often approach or equal those of actively-managed mutual funds. As always, read the fine print.

Complex ETFs

There are many, many ETFs that don’t necessarily bet on the stock market just going up. There are number of more complicated funds like leveraged ETFs and inverse exchange-traded funds. Unless you absolutely know what you’re doing and would, say, be able to explain how derivatives work to a third grader, you should avoid these ETFs like you would poison ivy at a picnic. Don’t be afraid of spiders, however. Spiders are simply how many refer to Standard and Poor’s Depositary Receipts (SPDR), some of the very first ETFs. The SPDR S&P 500, in fact, was the largest ETF in the world for many years.

Last Updated June 8, 2021

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