Stock Exchange-Traded Fund (ETF)

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DEFINITION of 'Stock Exchange-Traded Fund (ETF)'

A stock ETF, or exchange-traded fund, is an asset that tracks a particular set of equities, similar to an index. It trades just as a normal stock would on an exchange, but unlike a mutual fund, prices adjust throughout the day rather than at market close. These ETFs can track stocks in a single industry, such as energy, or an entire index of equities like the S&P 500. By doing so, investors can gain exposure to a basket of equities and limited company-specific risk associated with single stocks. This instant diversification comes in a simple, low cost, and tax efficient tool that can be accessed through most online brokerages. 

BREAKING DOWN 'Stock Exchange-Traded Fund (ETF)'

A stock ETF allows an investor to gain exposure to a basket of equities in a specific sector or index without having to purchase individual stocks. Owning diversified assets limits some unsystematic risk associated with company stocks. The original purpose of investing in an ETF was to meet long-term goals, but today they are traded like any other stock, in that investors can short or buy on margin. There is also a group of ETFs that bet against the success of an index or sector, meaning the asset performs well when the underlying asset struggles. Unlike a mutual fund, a stock ETF charges minimal management fees and carries low expense ratios. This makes it an ideal tool for investors of any skill level looking to maintain low costs and generate consistent returns.  

Benefits of 'Stock ETFs'

Stock ETFs offer investors a wealth of benefits so it makes sense that fund inflows have skyrocketed in recent years. As of July 2017, ETFs in the US accounted for over $3 trillion in assets under management or about 8% of the $26 trillion stock market. The broad advantages cannot go understated. They are an excellent option for investors looking to diversify their portfolio in a flexible, low cost, and tax efficient manner. In fact, a growing body of research suggests passive investments like stock ETFs tend to outperform actively managed funds over a long time frame. 

Different Styles of 'Stock ETFs' 

The more popular stock ETFs track benchmark indexes like the S&P 500 or Dow 30. The SPDR S&P 500 (SPY), maintained by State Street, is consistently the most active asset with average daily volume exceeding 65 million shares in the past 3 months. Other styles of stock ETFs adopt a factor based strategy that accounts for specific attributes like market capitalization, momentum, and value. This subset of assets is a popular strategy known as Smart Beta. It attempts to deliver better risk-adjusted returns than a conventional market cap weighted index. Sector funds are another popular ETF category that tracks the stocks of a specific industry like energy, financials, and technology.