WTF is an ETF?

Oh come on, that title’s hilarious. Alright, well let’s jump right into it.

An ETF, short for Exchange-Traded Fund, is a long term investor’s best friend. ETFs are perfect for anyone who wants to use a simple brokerage account to invest instead of, or in addition to, their tax-advantaged accounts. They are great for 3 main reasons. Reason number 1 is their diversification, number 2 is your ability to keep some control, and number 3 is their ease of use.

Diversification

Diversification is kind of the bread and butter of an ETF. To give some background, an ETF is just a fund controlled by another financial institution. The financial institution buys a variety of stocks in different amounts until it gets whatever level of diversification it wants. This bucket of stocks is the ETF. They then sell stock in the ETF. Something to note is that while you don’t technically own any of the stocks inside the ETF, the performance of those stocks is what dictates the performance of the ETF as a whole.

You can purchase stock in an ETF that tracks the whole stock market where it contains stocks from hundreds or even thousands of different companies.

Control

Chances are, if you are reading this, you aren’t Warren Buffet. That being said you may want to have just a bit of control in what you are buying into. With ETFs you can buy an ETF that contains stock in specific industries. You can buy an ETF that contains only stocks in social media, communications, even gold. This control combined with the diversification we talked about above is what makes ETFs so powerful. This allows you to invest in entertainment, but not bet only on Disney.

Ease of use

The ET in ETF is possibly the biggest attraction point for new investors. ETFs buy and sell just like any stock. You can find them on any brokerage account and they have their very own ticker symbols. You can day trade them if you want (please don’t) you can swing trade them (also don’t please) or you can hold onto them until retirement (that’s more like it).

Cons

There is really only 1 real con for ETFs, and that is the expense ratio. It’s not as complicated as it sounds. It’s essentially an assets under management fee. For some perspective, mutual funds charge on average 1.42% to handle your money. VTI (the ETF that I recommend) has an expense ratio of 0.03%. The reason I say this is a negative is that normal stocks have no expense ratio. With all of the other pros I listed, I am willing to pay the 3 hundredths of a percent.

I hope this clears up how an ETF works. If you are interested in learning more about saving and investing please start with Forget the Noise