What Is an ETF? | How Do Stocks Work?

An ETF (exchange-traded fund) is an investment fund that holds a basket of assets, such as stocks or bonds, and whose units trade on a stock exchange throughout the day, just like a single share. Buying one unit gives you a small slice of everything the fund owns.

How an ETF works

You trade it like a stock. You place an order through a brokerage account during market hours, using its ticker symbol, and pay the market price at that moment.
The fund owns the assets. Each unit’s underlying value, the net asset value (NAV), is the fund’s holdings divided by units outstanding.
Large firms keep price and value close. Specialist firms called authorized participants can create new units by delivering the underlying securities to the fund, or redeem units for those securities. If the ETF’s market price drifts above or below its NAV, they can profit by closing the gap, which tends to keep the two close. The detail is in ETFs vs mutual funds.

Most ETFs track an index, such as the S&P 500 or the S&P/TSX Composite, which makes them a common way to own an index fund.

A tiny example

A hypothetical ETF holds $500 million of stocks and has 10 million units outstanding, so its NAV is $50 per unit. You buy 20 units at the market price of $50.02 and pay $1,000.40. You now own a sliver of every company in the fund, and the fund’s expense ratio is taken out of its assets gradually, rather than billed to you.

Where ETFs started

The first successful exchange-traded index product was Canadian: Toronto 35 Index Participation Units (TIPs) launched on the Toronto Stock Exchange on March 9, 1990. The first US ETF, the SPDR S&P 500 ETF (SPY), followed on the American Stock Exchange in January 1993.

What to check before buying one

Cost. The expense ratio, or MER in Canada, varies widely. See how investment fees work.
What it holds. “ETF” describes the wrapper, not the contents. Some hold thousands of stocks, others a narrow theme or a single sector, which affects diversification.
Leveraged and inverse ETFs aim to multiply or reverse daily index moves. They reset every day and can behave very differently from what people expect over longer periods.
Trading costs. Thinly traded ETFs can have wide bid-ask spreads, so the price you pay may sit noticeably above NAV.