What Is an Exchange Traded Fund (ETF)?

Short for Exchange Traded Fund, an ETF is a basket of securities that includes assets such as stocks, bonds, commodities and cryptocurrencies, but trades as a single stock on an exchange. 

ETFs share many similarities with mutual funds, as both provide a way for investors to diversify returns and usually include a combination of asset classes. 

In contrast, mutual funds can only be bought and sold once in a day, after the market has closed. 

The price of an ETF will usually fluctuate throughout the day as it is sold. 

ETFs are commonly used by investors to diversify portfolios as they are often invested in more than one sector. 

Though an ETF can also be invested in just a single sector. 

ETFs typically track the performance of a single market index such as the S&P 500 Index, or the FTSE 100. 

Some of the most popular ETFs include the SPDR S&P 500 ETF Trust (SPY). This ETF tracks the S&P 500 Index. 

iShares Russell 2000 (IWM) tracks the Russell 2000 small-cap index. 

One of the biggest advantages of ETFs is usually the low cost associated with them, particularly if an ETF is passively managed, where it tracks the performance of an index. 

ETFs can also be actively managed, which means a portfolio manager will manage the ETF and make investment decisions not necessarily designed to mirror the performance of the underlying index. 

ETFs have two key tax advantages compared to mutual funds. The capital gains tax on the ETF is incurred only when the ETF is sold. But mutual funds carry capital gain tax changes throughout the investment horizon. 

ETF investors can also participate in short selling which involves selling a stock that is currently not owned by the investor and bought back at a later date when the price of the security in question falls.