What is an ETF?
An exchange-traded fund (ETF) is a fund—usually built to track an index or basket of assets—that's listed on an exchange and traded like a stock. One purchase gives you exposure to dozens or hundreds of holdings, and most ETFs disclose their holdings daily (Lettau & Madhavan, 2018).
How does an ETF stay close to its index?
Large firms called authorized participants (APs) keep prices in line. If an ETF trades above the value of what it holds—its net asset value (NAV)—APs create new shares and sell them; if it trades below, they buy shares and redeem them. That arbitrage keeps the market price near NAV.
| ETF | Mutual fund | |
|---|---|---|
| Trading | Intraday, in a brokerage account | Once a day at NAV |
| Costs | Usually low (especially index ETFs) | Often higher (active funds) |
| Holdings disclosure | Daily | Periodic |
| Minimum | Price of one share (or less with fractional shares) | Varies by fund |
What should you check before buying an ETF?
- Expense ratio: the yearly fee, which compounds into a big difference over decades.
- Premium/discount and tracking error: the gap between price and NAV, and between the ETF's return and its index.
- Trading volume: thinly traded ETFs have wider bid-ask spreads.
- Leveraged and inverse ETFs: they target 2x or −1x the daily return, so over longer periods results can drift far from the index—they're short-term tools.
Sharpe (1991) showed that after costs, the average actively managed dollar must underperform the market average, a key argument for low-cost index funds. On the flip side, research finds stocks with heavy ETF ownership tend to be more volatile (Ben-David et al., 2018). For why diversification works, see portfolio theory.
FAQ
- Are ETFs and index funds the same?
- Both can track an index, but ETFs trade throughout the day on an exchange, while index mutual funds trade once a day at NAV. Some ETFs, like active ETFs, don't track an index at all.
- Can you lose money in an ETF?
- Yes. An ETF is an investment, not a deposit, so if the assets it holds fall, so does its value.
Sources reviewed: 2026-10-25
References
- Lettau, M., & Madhavan, A. (2018). Exchange-traded funds 101 for economists. Journal of Economic Perspectives, 32(1), 135–154.
- Ben-David, I., Franzoni, F., & Moussawi, R. (2018). Do ETFs increase volatility? Journal of Finance, 73(6), 2471–2535.
- Sharpe, W. F. (1991). The arithmetic of active management. Financial Analysts Journal, 47(1), 7–9.