The investing world loooooves its acronyms. You’ve got DJIA (Dow Jones Industrial Average), REIT (real estate investment trust), and — very on-brand with the bro-ey imagery here — FAANG stocks (Facebook, Amazon, Apple, Netflix, and Google).
Among these gazillions of examples is ETF, which stands for “exchange-traded fund.” Apologies for yet another acronym, but we definitely aren’t sorry about bringing ETFs to your attention — they’re a type of investment that can be really useful in an investment portfolio. In fact, there is more than $5 trillion invested in ETFs globally, and ETFs account for about a quarter of daily trading activity in US stock markets.
So, WTF is an ETF?
OK, exchange-traded fund — let’s break that down. As a type of fund, an ETF is a set of lots of individual investments (stocks, bonds, and / or alternatives) that have been pooled together into a single entity. Basically an investment playlist.
Investors can buy shares of that fund and trade them on a stock exchange. So when you buy shares of an ETF, you’re actually getting a little bit of ownership in many investments all at once.
Unlike other types of funds, which are often “actively managed” (meaning people who work there actively choose and manage all the investments in the fund in order to try to beat the market), ETFs are typically “passive,” meaning they’re built to match the market, an industry, or a certain type of company by mirroring a benchmark — such as the S&P 500, which includes the 500 largest public companies in the US.
Investors can also use ETFs to get different types of investments — there are stock ETFs, bond ETFs, commodity ETFs, and so on and so forth. And because shares of ETFs trade on a stock exchange, investing in ETFs makes it easier to get all those different asset classes into your investment portfolio. (You can see the funds that Ellevest uses to build investment portfolios for online clients here.)
Two big benefits of ETFs
Because ETFs allow you to own small pieces of lots of different individual investments, ETFs bring diversification to your investment portfolio. That helps to reduce your portfolio’s overall risk.
For example, if you owned shares of stock in Company X, anything that affects its stock price — good things, like healthy profits, or bad things, like a major security breach or a scandal with the CEO — would have a direct impact on the value of your investments. But if, instead, you owned shares of an ETF that includes stock in Company X (along with many others), those things wouldn’t impact the value of your investments as much. True, you wouldn’t benefit quite as much from the good stuff, but you’d be a lot more sheltered from the bad.
Nearly all the investments we include in Ellevest portfolios for online clients are ETFs. When your Ellevest dashboard shows “89% stock, 11% bonds,” for example, that means 89% of your investments are in stock ETFs, and 11% are in bond ETFs (unless you’ve chosen an Ellevest Impact Portfolio, which might also include some mutual funds designed to power positive change by advancing women).
Any fund you invest in — no matter how you do your investing — will have management fees attached to it. (That’s in addition to any advisory fees that go to an investment advisor like Ellevest.) The management fee goes toward paying the people who work for the fund company to manage the fund’s investments.
Because ETFs are passive, they don’t require the fund company to do as much work to keep them running. So ETFs generally have low management fees — some charge as little as tenths of a percentage on your assets. (Compare that to a common 1%+ fee for actively managed mutual funds. Yeah.) That’s good news for your bottom line, because high fees can really eat into your returns.
Management fees are important, but they’re not the only thing that affects an ETF’s cost. Other things do too, like the tracking error (how closely the fund gets to mirroring its underlying benchmark), the “bid / ask spread” (the difference between the asking purchase price and asking selling price), and the average number of shares traded each day. When we pick ETFs to include in Ellevest portfolios, we aren’t just looking at the management fees (although that’s certainly important). We also try to find a balance between fees and all those other factors, so we’re keeping your total costs low.
So that’s why we’re such big fans of ETFs here at Ellevest: built-in diversification and low costs — both of which, we believe, can be big for your financial goals. Ready to get started?