ETFs are referred to as “funds” due to their similarities to mutual funds. However, ETFs are traded on the stock exchange. Unlike a stock, which focuses on one company, an ETF has a wider range of focus. An ETF is a fund or security composed of a collection of other securities such as stocks and bonds. It’s constructed similarly to a mutual fund, but is traded on the stock exchange. An ETF often tracks indexes and is able to trade throughout the day unlike mutual funds which trade once per day. An ETF has an associated price that allows the purchase and redemption of shares to occur easily.
ETFs are also known for being low-cost investment options. ETFs can consist of hundreds or thousands of stocks and bonds. To obtain that type of diversity, an investor would incur a large number of trading transaction costs and be forced to meet some high minimum purchase requirements in a lot of cases. ETFs can be utilized as a way to obtain that diversity at a low cost. ETFs are less expensive than mutual funds because they do not charge 12b-1 fees or commissions. Therefore, fewer operational expenses lead to reduced expense ratios for the investor.