What Is an ETF?

Exchange-traded funds — ETFs — are one of the most important financial innovations of the past 30 years. They let you buy a basket of hundreds or thousands of investments in a single trade, just like buying a share of stock. Since the first U.S. ETF launched in 1993, they've grown to hold over $8 trillion in assets. There's a good chance the best investment for your portfolio is an ETF you've never heard of.

How It Works

An ETF is a fund that holds a collection of investments — stocks, bonds, commodities, or a mix — and trades on a stock exchange just like an individual stock. When you buy one share of the SPDR S&P 500 ETF (ticker: SPY), you're buying a tiny slice of all 500 companies in the S&P 500.

ETFs are similar to mutual funds in that they pool investors' money to buy a diversified basket of securities. But they differ in several important ways:

Trading flexibility. Mutual funds only trade once per day, after the market closes, at a single price called the Net Asset Value (NAV). ETFs trade continuously throughout the day, just like stocks. You can buy at 10:03 AM and sell at 2:47 PM if you want.

Lower costs. ETFs generally have lower expense ratios than equivalent mutual funds. The Vanguard S&P 500 ETF (VOO) charges 0.03% per year. Many thematic and bond ETFs charge under 0.10%.

Tax efficiency. ETFs use a clever "creation and redemption" mechanism that allows them to minimize capital gains distributions. Most ETF investors won't owe taxes until they actually sell — a huge advantage over mutual funds, which often distribute taxable capital gains even if you didn't sell anything.

No minimums. Many mutual funds require a $1,000-$3,000 minimum investment. ETFs have no minimum beyond the price of a single share — and with fractional shares now available at most brokerages, you can start with as little as $1.

There are ETFs for virtually everything: U.S. large caps (VOO, SPY), total international markets (VXUS), bonds (BND, AGG), REITs (VNQ), gold (GLD), sectors like technology (XLK) or healthcare (XLV), and even more exotic strategies like covered calls (JEPI) or volatility (VXX).

Why It Matters for Investors

ETFs democratized investing. Before ETFs, getting diversified exposure to international markets, commodities, or bonds required expensive funds or separate accounts. Today, you can build a globally diversified portfolio with just three ETFs:

• VTI — Total U.S. Stock Market (~4,000 stocks, 0.03% fee)
• VXUS — Total International Stock Market (~8,000 stocks, 0.07% fee)
• BND — Total U.S. Bond Market (~10,000 bonds, 0.03% fee)

That's your entire portfolio: 22,000+ securities across the globe for an average fee of about 0.04% per year. Twenty years ago, this level of diversification was only available to institutional investors paying much higher fees.

ETFs also make tactical moves easy. Want to add gold exposure during inflationary times? Buy GLD. Want more small-cap value? Buy VBR. Want dividend income? Buy VYM or SCHD. Each is a single trade that gives you exposure to dozens or hundreds of holdings.

Real Example

Here's the "Three-Fund Portfolio" — a wildly popular strategy built entirely with ETFs. If you'd invested $10,000 in January 2010, split 60% VTI, 30% VXUS, and 10% BND, and rebalanced annually:

• By December 2023: Your $10,000 grew to approximately $38,500.
• Annualized return: About 10.2%.
• Total fees paid: Roughly $55 over the entire 14-year period.
• Number of individual securities owned: Over 20,000 stocks and bonds.

Compare that to the average investor who picks individual stocks. According to J.P. Morgan, the average retail investor earned just 3.6% per year from 2003-2023, largely due to bad timing, emotional trading, and poor diversification. The boring three-ETF portfolio would have crushed them — at a total cost of less than a single dinner out.