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exchange-traded fund

Also called: ETF

A fund whose units trade on a stock exchange during the day like shares; many ETFs are index funds.

An ETF, or exchange-traded fund, is a fund whose units trade on a stock exchange during the day, just like shares. You buy and sell them through a broker at the market price, which normally stays close to the value of what the fund holds. Many ETFs are index funds, but the wrapper says nothing about what is inside.

When reading an ETF's factsheet, a few details matter. Accumulating ETFs reinvest dividends, distributing ones pay them out. Physical ETFs hold the actual securities, synthetic ones use contracts to copy the index. The fund's domicile, the country where it is registered, affects dividend taxes and who can buy it.

An ETF has costs beyond its ongoing charge: the spread between buy and sell prices, currency conversion and platform fees. Easy trading is also a trap, because buying and selling often adds costs and invites bad timing.

Example

Zapas compares six fictional factsheets. Zapas World Stock is an index ETF on Tessaro World: EU-domiciled UCITS, accumulating, physical, 0.20% ongoing charge. Halden World Index tracks the same index for only 0.05%, but it is US-domiciled and distributing, with 30% tax withheld on dividends and higher FX and platform fees.

All in, over 10 years, Zapas World Stock costs about 0.61% a year ($61 on $10,000) and Halden 1.20% ($120). Robo Theme is also an ETF, yet it is a synthetic fund on one sector with 60 holdings. The funds are invented for the course.

Common mistakes

  • Assuming ETF means index fund, or index fund means diversified.
  • Trading an ETF often just because it is possible.
  • Choosing by the headline fee and ignoring spread, FX, platform fees and domicile.
  • Investments can fall, and you can get back less than you put in.

Learn it in the course