A:

An exchange-traded fund (ETF) is a security that tracks an index but has the flexibility of trading like a stock. Just like an index fund, an ETF represents a basket of stocks that reflects an index. The difference is that an ETF isn't a mutual fund - it trades just like any other company on a stock exchange. The high management fees and the lack of liquidity of index mutual funds have made ETFs increasingly popular investment vehicles. Almost every one of today's major indexes has an ETF tracking its performance, and most ETFs are passively managed by some form of trust company. These trust companies take on the responsibility of maintaining the portfolio of stocks within the index to which they are linked. The trust company transforms the portfolio into individual shares of ETFs, which are then sold and purchased on the AMEX like regular stocks, such as the Spiders and Diamonds ETFs.

Even though ETFs are passively managed and mimic a specific index, charges are incurred for these services. These charges are typically lower than those of index funds and are used for day-to-day operations, maintenance of the index portfolio, and payment of employee salaries. Part of the maintenance of the portfolio entails the collection and safekeeping of dividends paid by companies within the index portfolio. It is the duty of the trust companies to distribute these payments to the ETF stockholders; the distributions are normally made on a periodic basis.

RELATED FAQS
  1. Should I invest in ETFs or index funds?

    Learn advantages to investing in exchange-traded funds, or ETFs, and index funds, and decide whether to include them in your ... Read Answer >>
  2. Do ETFs pay capital gains?

    Learn about exchange-traded funds (ETFs), which can generate capital gains for their shareholders due to occasional and substantial ... Read Answer >>
  3. In what ways are ETFs more tax efficient than mutual funds?

    Compare mutual funds and exchange-traded funds to find out which one offers the most advantageous tax position for investors ... Read Answer >>
  4. What types of fees are incurred by purchasing ETFs?

    Understand all the various costs, both explicit and hidden, involved in trading exchange-traded funds, or ETFs, and see how ... Read Answer >>
Related Articles
  1. Financial Advisor

    Advising FAs: Explaining ETFs to a Client

    Exchange traded funds (ETFs) have exploded in popularity with both investors and professionals for several reasons, and their growth shows no sign of slowing.
  2. Investing

    The Advantages of ETFs Compared to Index Funds

    With the ongoing ETF boom, ETFs gain more variety and increased competition in the market leads to further investors' advantages compared to index funds.
  3. Investing

    The Main Attractions of ETF Investing (SPY)

    As the popularity of ETFs soar, a look at the main benefits of these investment vehicles.
  4. Investing

    Introduction to Exchange-Traded Funds

    Get into ETFs and enjoy the benefits of a mutual fund with the flexibility of a stock.
  5. Investing

    5 Reasons to Pick ETFs Over Mutual Funds

    Discover five reasons why average investors and sophisticated hedge funds choose ETFs instead of mutual funds to meet their investment goals.
  6. Investing

    A Look At the Growth Of the ETF Industry

    Explore the phenomenal growth rate of the ETF industry, and learn some of the principal reasons why ETFs are projected to continue to grow at a rapid pace.
  7. Investing

    Advantages and Disadvantages Of ETFs

    You've probably heard that ETFs are better than mutual funds, but you need to consider all aspects before investing.
RELATED TERMS
  1. Index ETF

    Exchange-traded funds that follow a specific benchmark index ...
  2. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets ...
  3. Stock ETF

    A security that tracks a particular set of equities, similar ...
  4. Passive ETF

    One of two types of exchange-traded funds (ETFs) available for ...
  5. ETF Sponsor

    The company or financial institution which creates and administers ...
  6. Redemption Mechanism

    Refers to how market makers of exchange traded funds (ETF) can ...
Hot Definitions
  1. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  2. Down Round

    A round of financing where investors purchase stock from a company at a lower valuation than the valuation placed upon the ...
  3. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  4. Portfolio Investment

    A holding of an asset in a portfolio. A portfolio investment is made with the expectation of earning a return on it. This ...
  5. Treynor Ratio

    A ratio developed by Jack Treynor that measures returns earned in excess of that which could have been earned on a riskless ...
  6. Buyback

    The repurchase of outstanding shares (repurchase) by a company in order to reduce the number of shares on the market. Companies ...
Trading Center