An exchange-traded fund, ETF for short, is an investment fund that lets you buy a large basket of individual stocks or government and corporate bonds in one purchase. Think of ETFs as investment wrappers, like a tortilla that holds together the component ingredients of a burrito, but instead of tomatoes and rice and lettuce and cheese, these burritos are filled with stocks or bonds and are considerably less delicious to eat with salsa.
Want to dive in deeper to a specific topic on ETFs? Check out these other explainers we’ve written (but then come back here, because this is gonna be good).
An ETF is similar to a mutual fund, which is another way to purchase many stocks at one time, but there are a few major differences. Whereas mutual funds tend to have human mutual fund managers who actively trade stocks in and out of the fund based on which ones they predict will go up or down, the vast majority of ETFs are not managed by humans.
Instead, many ETFs are programmed with an algorithm that tracks an entire economic sector or index, like the S&P 500 or the United States bond market. For this reason, mutual funds are generally referred to as being “actively managed” and ETFs “passively managed,” though there are many exceptions to this rule.
Also, unlike mutual funds, which are priced just once a day, ETFs can be bought and sold during the entire trading day just like individual stocks. This explains why they’re called “exchange traded” funds.
Types of ETFs
Though ETF varieties aren’t nearly as plentiful as grains of sand on the world’s beaches, there are a shocking number and variety of them, possibly even more in number than the “Fast & Furious” sequels and spinoffs — and their numbers are growing every day. Here are the major asset classes and investment products included in the biggest ETF categories.
Stock Market Tracking ETFs
ETFs that mirror indices like the stock or bond market have attracted by far the most investment from individual investors. One popular version allows investors to own a small stake of the American economy by seeking to mirror the S&P 500, an index of the 500 publicly traded American companies with the highest market capitalizations. Since the S&P 500 or other large indexes like the Dow Jones Industrial Average or the NASDAQ-100 naturally favor the largest companies, those who seek to diversify their holdings with smaller companies may also want to consider ETFs that track different sectors. The S&P 400, for instance, tracks midcap publicly traded companies and the Russell 2000 tracks small-cap public companies.
Sector Tracking ETFs
Should you want to focus on a particular sector of the economy, rather than the entirety of it, you may want to invest in sector tracking ETFs. Two financial research giants, MSCI and S&P, developed a taxonomy of the global economy that could locate all publicly traded companies in one of 11 main sectors and dubbed it the Global Industry Classification Standard (GICS).
The sectors in the GICS are:
Communication services
Consumer discretionary
Consumer staples
Energy
Financials
Health care
Industrials
Information technology
Materials
Real estate
Utilities
Not only will you find multiple ETFs tracking each of these sectors, ETFs are now also available that track the subcategories of each sector, which from largest to smallest are categorized as Industry Group, Industry, and Sub-Industry. So if you specifically want to focus on an area like crude oil companies, there’s an ETF for that. MSCI hosts a handy interactive tool that provides an overview of all 11 sectors and their subcategories.
International ETFs
Those who want exposure to international stocks may choose to invest in one of several types of international ETFs, described below.
ETFs that focus on all economies outside the United States
An ETF like Vanguard’s Total International Stock ETF seeks to “track the performance…of stocks issued by companies located in developed and emerging markets, excluding the United States.” So one price will buy you exposure to most all economies outside of the US. You can also invest in ETFs that track the stock markets of specific countries, like the Toronto Stock Exchange or the Tokyo Stock Exchange.
ETFs that focus on developed markets
Developed markets are the markets of countries that have well-established economies, generally an established rule of law, and are technologically advanced relative to other countries in the world. A few examples of developed countries are Australia, Japan, and Germany. A developed market ETF would provide broad exposure to all developed markets. BlackRock’s iShares MSCI EAFE ETF is a prominent example.
ETFs that focus on emerging markets
The phrase “emerging markets” was coined in 1981 by economist Antoine van Agtmael when he was working for the World Bank’s International Finance Corporation. It was offered as an alternative to the negative connotations suggested by the phrase “third world.” Emerging economies — like those of Brazil, China, Russia, and Turkey — are countries with relatively low per capita average salaries that are less politically stable than developed markets but open to international investment. Though investing in emerging markets tends to be riskier than developed ones, the risk is somewhat mitigated when an ETF invests in many, many emerging markets. Vanguard’s FTSE Emerging Markets ETF, the largest of the type by assets under management, seeks to “closely track the return of the FTSE Emerging Markets All Cap China A Inclusion Index.”
ETFs that focus on the economy of one country outside the U.S.
Got a (inexcusably cheesy pun alert) yen to invest in the Japanese economy? BlackRock iShares MSCI Japan ETF promises investors the ability to “access the Japanese stock market in a single trade." There are multiple ways to invest in any economy. And if you ever read up on how difficult it is to buy some foreign stocks, like South Korea’s Samsung, you may decide it’s preferable and a lot easier to buy, for example, a South Korea ETF. iShares MSCI South Korea ETF will not only get you a stake in the Galaxy phone maker, but also a bit of Hyundai motors for diversification’s sake.
Thematic ETFs
If ETFs were a family of mostly straight-laced marketable assets, thematic ETFs would represent the quirky cousin with the handlebar mustache and big parrot on his shoulder. Some of these ETFs seek to make a statement by investing only in companies that are environmentally friendly. They’re known as ESG (environmental, social, and corporate governance) funds, or socially responsible funds. Others act as financial trendspotters, like the burgeoning _high-_growth marijuana ETFs, created to take financial advantage of the loosening cannabis laws in Canada and the U.S.
Some thematic ETFs are actively managed and come with considerably higher management expense ratios that often approach or equal those of actively managed mutual funds. But then there are the Wealthsimple options. Our socially responsible investments and halal ETFs will give you the focused exposure you want — and they have some of the lowest costs in the industry.
Complex ETFs
There are many, many ETFs that don’t necessarily bet on the stock market just going up. These leveraged ETFs and inverse exchange-traded funds should be avoided by the average investor — unless you absolutely know what you’re doing and would, say, be able to explain how derivatives work to a third-grader.
Don’t be afraid of spiders, however. Spiders are simply how many refer to Standard & Poor’s Depositary Receipts (SPDR), some of the very first ETFs. The SPDR S&P 500, in fact, was the largest ETF in the world for many years.
