Exchange-Traded Fund (ETF)
An exchange-traded fund (ETF) is an investment fund that trades on stock exchanges like individual stocks, typically tracking an index while offering diversification, low costs, and tax efficiency.
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Exam Tip
ETFs trade like stocks throughout the day. More tax-efficient than mutual funds. May trade at premium or discount to NAV.
What is an ETF?
An Exchange-Traded Fund (ETF) is a basket of securities that trades on an exchange throughout the day, like a stock. Most ETFs track an index, offering broad diversification with the trading flexibility of stocks.
ETF vs. Mutual Fund
| Feature | ETF | Mutual Fund |
|---|---|---|
| Trading | Throughout the day | End of day (NAV) |
| Pricing | Market price (bid/ask) | NAV only |
| Minimum Investment | One share | Often $1,000+ |
| Expense Ratios | Generally lower | Generally higher |
| Tax Efficiency | Higher | Lower |
| Commissions | May apply | Often no-load available |
Types of ETFs
| Type | Description |
|---|---|
| Index ETF | Tracks broad market index (S&P 500) |
| Sector ETF | Focuses on specific industry |
| Bond ETF | Holds fixed-income securities |
| Commodity ETF | Tracks commodity prices |
| International ETF | Foreign market exposure |
| Inverse/Leveraged | Amplified or opposite market returns |
Benefits of ETFs
| Benefit | Description |
|---|---|
| Diversification | Own basket of securities |
| Low Cost | Typically low expense ratios |
| Tax Efficiency | In-kind creation/redemption process |
| Transparency | Holdings disclosed daily |
| Liquidity | Trade anytime market is open |
| Flexibility | Limit orders, short selling, options |
ETF Pricing
ETFs trade at prices that may differ from NAV:
- Premium: Trading above NAV
- Discount: Trading below NAV
- Arbitrage keeps prices close to NAV
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Mutual Fund
A mutual fund is a professionally managed investment vehicle that pools money from multiple investors to purchase a diversified portfolio of securities.
Index Fund
An index fund is a mutual fund or ETF designed to track the performance of a specific market index (like the S&P 500) by holding the same securities in the same proportions, offering broad diversification with low fees.
Net Asset Value (NAV)
NAV is the per-share value of a mutual fund or ETF, calculated by dividing total assets minus liabilities by the number of outstanding shares.
Diversification
Diversification is an investment strategy that spreads investments across various assets, sectors, or geographic regions to reduce risk without necessarily sacrificing returns.
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