Exchange Traded Funds, or ETFs, have revolutionized the way people invest. They combine the diversification benefits of mutual funds with the trading flexibility of stocks. If you are new to investing, ETFs are one of the best places to start building your portfolio.
What Exactly is an ETF?
An ETF is a basket of securities that trades on a stock exchange, just like a regular stock. When you buy one share of an ETF, you are buying a small piece of all the investments inside that fund.
Think of it like a variety pack: Instead of buying individual candy bars, you buy a pack that contains 10 different types. With ETFs, instead of buying individual stocks, you buy a fund that might contain 500 different companies. One purchase gives you instant diversification.
How Do ETFs Work?
ETFs work by pooling money from many investors to buy a collection of assets. Most ETFs track an index, which is a list of stocks that meet certain criteria.
Example: The SPY ETF
SPY tracks the S&P 500 index, which includes 500 of the largest US companies. When you buy one share of SPY:
- You own a tiny piece of Apple, Microsoft, Amazon, Google, and 496 other companies
- If the overall market goes up, your ETF goes up
- If some companies do poorly, others may do well, balancing out your returns
Types of ETFs
There are ETFs for almost every investment strategy imaginable:
1. Index ETFs
These track major market indexes like the S&P 500, NASDAQ 100, or Dow Jones. They offer broad market exposure with low fees. Examples include SPY, QQQ, and DIA.
2. Sector ETFs
These focus on specific industries like technology, healthcare, energy, or financials. XLK tracks technology, XLF tracks financials, and XLE tracks energy companies.
3. Bond ETFs
These hold government or corporate bonds, providing income and stability. BND and AGG are popular bond ETFs that offer diversified fixed income exposure.
4. International ETFs
These invest in companies outside the United States. VEA holds developed market stocks, while VWO focuses on emerging markets.
5. Commodity ETFs
These track commodities like gold, silver, or oil. GLD tracks the price of gold, while USO tracks crude oil futures.
6. Dividend ETFs
These focus on companies that pay regular dividends. VYM and SCHD are popular choices for income-focused investors.
Benefits of ETF Investing
- Instant diversification: One ETF can give you exposure to hundreds or thousands of securities
- Low costs: Most ETFs have expense ratios under 0.20%, far cheaper than actively managed funds
- Trading flexibility: Unlike mutual funds, you can buy and sell ETFs throughout the trading day
- Transparency: ETFs disclose their holdings daily, so you always know what you own
- Tax efficiency: ETFs typically generate fewer taxable events than mutual funds
- No minimum investment: You can start with the price of a single share, sometimes under $50
Popular ETFs Every Investor Should Know
Here are some of the most widely traded ETFs:
- SPY: Tracks the S&P 500, the benchmark for the US stock market
- QQQ: Tracks the NASDAQ 100, heavy on technology stocks
- VTI: Total US stock market, including small and mid-cap companies
- VOO: Another S&P 500 ETF with a lower expense ratio than SPY
- IWM: Russell 2000, focusing on small-cap stocks
- VEA: Developed international markets outside the US
- BND: Total US bond market for fixed income exposure
How to Buy ETFs
Buying an ETF is just like buying a stock:
- Open a brokerage account (most have zero commissions for ETFs)
- Search for the ETF by its ticker symbol
- Decide how many shares you want to buy
- Place a market or limit order
- Your shares will be in your account within seconds
ETF Costs to Understand
While ETFs are generally low-cost, there are a few expenses to be aware of:
- Expense ratio: The annual fee charged by the fund, expressed as a percentage of your investment
- Bid-ask spread: The small difference between buying and selling prices
- Commission: Most brokers now offer commission-free ETF trading
Cost comparison: A typical index ETF charges 0.03% to 0.20% annually. That means on a $10,000 investment, you pay just $3 to $20 per year. Compare that to actively managed mutual funds charging 1% or more, which would cost $100 or more annually.
ETFs vs Individual Stocks
Should you buy ETFs or individual stocks? Here is how to think about it:
- Choose ETFs if: You want diversification, have limited time for research, or are building a long-term portfolio
- Choose individual stocks if: You enjoy researching companies, want to potentially beat the market, or have strong convictions about specific businesses
- Many investors do both: Use ETFs for core holdings and add individual stocks for companies you believe in
Common ETF Investing Mistakes
- Overcomplicating: You do not need 20 ETFs. A simple portfolio of 3 to 5 funds can provide excellent diversification
- Ignoring overlap: Some ETFs hold the same stocks. Owning SPY and VOO is redundant
- Trading too much: ETFs are best for long-term investing, not day trading
- Chasing performance: Last year's best-performing ETF may not repeat its success
- Not checking expenses: Small differences in fees compound into big differences over time
Track Your ETF Portfolio
Pro Trader Dashboard helps you monitor your ETF investments alongside individual stocks and options. See your total portfolio performance in one place.
Getting Started with ETF Investing
If you are new to investing, here is a simple approach:
- Start with a broad market ETF like VTI or VOO
- Add international exposure with VEA or VXUS
- Consider bonds with BND if you want stability
- Invest regularly through dollar cost averaging
- Rebalance annually to maintain your target allocation
Summary
ETFs are one of the best tools available for building wealth over time. They offer diversification, low costs, and simplicity that works for beginners and professionals alike. Whether you want to track the entire stock market or focus on specific sectors, there is an ETF for your investment goals.
Ready to learn more? Check out our guide on ETFs vs Mutual Funds or learn how to invest in SPY.