Exchange-traded funds

Definition

Exchange-traded funds (ETFs) are investment funds that are traded on stock exchanges, much like individual stocks. They hold a collection of assets such as stocks, bonds, or commodities and aim to track the performance of a specific index or asset class. ETFs offer investors a flexible and cost-effective way to diversify their portfolios and access various markets without having to buy individual securities.

5 Must Know Facts For Your Next Test

1. ETFs are traded throughout the day on stock exchanges, allowing investors to buy and sell them at market prices, similar to individual stocks.
2. One major advantage of ETFs is their typically lower expense ratios compared to mutual funds, making them a cost-effective investment option.
3. ETFs provide diversification by holding a variety of assets within a single fund, which helps reduce risk for investors.
4. Many ETFs are designed to track specific indices, such as the S&P 500 or Nasdaq, allowing investors to gain exposure to broad market movements.
5. ETFs can also be structured to provide different investment strategies, including those focused on dividends, growth, or sector-specific investments.

Review Questions

• How do exchange-traded funds differ from mutual funds in terms of trading and management?
  • Exchange-traded funds (ETFs) differ from mutual funds primarily in their trading mechanisms and pricing. ETFs are traded on stock exchanges throughout the trading day, allowing for real-time price fluctuations and transactions at market prices. In contrast, mutual funds are only traded at the end of the trading day at their net asset value (NAV). Additionally, ETFs often have lower management fees compared to mutual funds due to their passive management strategies.
• What are the implications of liquidity for investors in exchange-traded funds compared to traditional mutual funds?
  • Liquidity plays a significant role for investors in exchange-traded funds (ETFs) compared to traditional mutual funds. Because ETFs can be bought and sold throughout the trading day, they offer investors immediate access to their investments at market prices. This contrasts with mutual funds, where transactions occur only at the end of the day based on the NAV. Increased liquidity allows ETF investors to respond quickly to market changes and adjust their portfolios more dynamically.
• Evaluate how exchange-traded funds have transformed investment strategies for individual investors in recent years.
  • Exchange-traded funds (ETFs) have significantly transformed investment strategies for individual investors by providing greater access to diversified portfolios with lower costs and increased flexibility. With the ability to trade ETFs like stocks throughout the day, investors can implement strategies such as tactical asset allocation and risk management more effectively. Additionally, the rise of sector-specific and thematic ETFs has empowered individual investors to tailor their investments according to personal interests or beliefs while still maintaining a diversified approach. This democratization of investing has made sophisticated strategies more attainable for everyday investors.

Related terms

mutual funds:

Mutual funds are investment vehicles that pool money from multiple investors to purchase a diversified portfolio of stocks, bonds, or other securities, managed by professional fund managers.

index funds: Index funds are a type of mutual fund or ETF designed to replicate the performance of a specific market index by holding the same securities in the same proportions.

liquidity:

Liquidity refers to how quickly and easily an asset can be bought or sold in the market without affecting its price, which is one of the key advantages of ETFs.