Introduction to ETFs

Exchange-Traded Funds (ETFs) have revolutionized investing by making diversification simple and affordable. Understanding ETFs is essential for modern portfolio construction. [DEFINITION] ETF (Exchange-Traded Fund): An investment fund that trades on stock exchanges like a regular stock, typically tracking an index, sector, commodity, or other assets. ETFs combine mutual fund diversification with stock-like trading flexibility. ### How ETFs Work ETFs hold a basket of securities designed to track a specific benchmark: - **Index ETFs:** Track market indices (SPY tracks S&P 500) - **Sector ETFs:** Focus on specific industries (XLF for financials) - **Bond ETFs:** Hold fixed-income securities (BND for total bond market) - **Commodity ETFs:** Track commodities like gold (GLD) or oil (USO) - **International ETFs:** Provide foreign market exposure (EFA, VWO) [EXAMPLE] SPY (SPDR S&P 500 ETF) holds all 500 stocks in the S&P 500 in proportion to their market cap. When you buy one share of SPY (~$450), you own a tiny piece of Apple, Microsoft, Amazon, and 497 other companies instantly. ### ETFs vs Mutual Funds | Feature | ETFs | Mutual Funds | |---------|------|--------------| | Trading | Throughout day | End of day only | | Minimum | One share | Often $1,000+ | | Expense ratios | Usually lower | Often higher | | Tax efficiency | More efficient | Less efficient | | Transparency | Holdings visible daily | Quarterly disclosure | [TIP] Most long-term investors should start with broad market ETFs like VTI (total US market) or VOO (S&P 500). These provide instant diversification with expense ratios under 0.10%. [KEY] ETFs have expense ratios—annual fees charged as a percentage of assets. A 0.03% expense ratio means you pay $3 annually per $10,000 invested. Lower is better. ### Popular ETFs by Category **US Market:** - SPY, VOO, IVV: S&P 500 - VTI, ITOT: Total US market - QQQ: Nasdaq 100 **International:** - VEU, VXUS: International developed + emerging - EFA: Developed markets - VWO, EEM: Emerging markets **Bonds:** - BND, AGG: Total bond market - TLT: Long-term Treasury - HYG: High-yield corporate [EXERCISE] You want to build a simple three-fund portfolio: 60% US stocks, 30% international stocks, 10% bonds. Which ETFs would you use and in what proportions? |ANSWER| Example allocation: 60% VTI (total US market), 30% VXUS (total international), 10% BND (total bond market). This gives you exposure to thousands of stocks and bonds worldwide with just three holdings. [WARNING] Some specialized ETFs (leveraged, inverse, or exotic commodities) are designed for short-term trading and can lose significant value over time. Stick to standard index ETFs for long-term investing.