What Is an ETF? Index Funds vs ETFs Explained
How exchange-traded funds work and why they are popular with beginners.
What is an ETF?
An ETF (exchange-traded fund) is a basket of securities — stocks, bonds, or commodities — that trades on a stock exchange just like a single share. When you buy one share of an ETF like SPY, you instantly own a tiny slice of all 500 companies in the S&P 500.
ETFs were created so everyday investors could own a diversified portfolio without picking individual stocks. Today there are over 8,000 ETFs covering every market, sector, and strategy imaginable.
ETF vs mutual fund vs individual stock
| Feature | ETF | Mutual Fund | Individual Stock |
|---|---|---|---|
| Trades like | A stock (any time) | Once per day at close | A stock (any time) |
| Diversification | Built-in | Built-in | None |
| Typical fees | 0.03% - 0.75% | 0.5% - 1.5% | $0 commissions |
| Minimum investment | 1 share (or $1 with fractional) | Often $1,000+ | 1 share |
| Tax efficiency | High | Lower | Depends on trading |
What is an expense ratio?
The expense ratio is the annual fee an ETF charges as a percentage of your investment. It is deducted automatically — you never see a bill.
Example: SPY has a 0.0945% expense ratio. On $10,000 invested, you pay roughly $9.45 per year. A managed mutual fund at 1% costs $100 on the same amount.
Index ETFs — those that track a market index like the S&P 500 — have the lowest fees because no one is actively picking stocks.
Types of ETFs
| Type | What it tracks | Example |
|---|---|---|
| Broad market | Entire U.S. stock market | VTI, ITOT |
| S&P 500 | 500 largest U.S. companies | SPY, VOO, IVV |
| NASDAQ / tech | Top 100 NASDAQ stocks | QQQ, ONEQ |
| Sector | One sector only (tech, energy, etc.) | XLK, XLE, XLF |
| International | Non-U.S. markets | VEA, EEM |
| Bond | Government or corporate bonds | BND, TLT |
ETF vs index fund — what is the difference?
The terms are often used interchangeably. Technically:
- An index fund is a mutual fund that tracks an index (traded once per day).
- An index ETF tracks the same index but trades intraday like a stock.
For most beginners, both are excellent low-cost options. ETFs are slightly more flexible; index mutual funds sometimes have no minimum investment when bought through a broker like Fidelity.
Why do beginners love ETFs?
- Instant diversification — one purchase spreads risk across dozens or hundreds of stocks.
- Low cost — index ETFs charge 0.03-0.10% vs 1%+ for managed funds.
- Easy to buy — any brokerage account can buy ETFs like stocks.
- Transparency — you always know exactly what an ETF holds.