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Stock Market Basics: What is an ETF?

December 6, 2017
ETF definition

ETFs, or exchange traded funds, have become increasingly popular in recent years. They allow investors to diversify their portfolios without incurring excessive fees, while at the same time mitigating risk. For passive investors, they are an invaluable resource.

As part of our Stock Market Basics series, we’ve put together this guide to help novice investors get the most out of ETFs.

What is an ETF?

Simply put, ETFs are funds – consisting of assets like stocks, bonds, foreign currencies, or commodities – that trade on an exchange like a stock.

Typically, ETFs attempt to track the performance of a particular index – the S&P/TSX Composite Index, the S&P/TSX 60 Index, or the Dow Jones Industrial Average, for example. They do so not by owning every stock contained in the index, but by owning select stocks which closely track the index’s performance. By purchasing shares of an ETF, investors are able to gain exposure to an array of stocks through a single security.

What are the benefits of ETFs?

The benefits of ETFs are many. For one, they allow investors to diversify their portfolios without paying commission fees for multiple trades. ETFs also make it possible to gain exposure to more expensive stocks – like Amazon or Constellation Software – without purchasing shares in the company directly

Also, because ETFs are designed to match, not beat, the performance of an index, they lend themselves to passive management. Generally speaking, ETF managers trade assets less frequently than mutual fund managers, who attempt to outperform the market. Because of this, ETFs tend to have fewer administrative fees, and depend less on the abilities of individual managers.

Lastly, because ETFs can be bought and sold during regular trading hours, they are more liquid than mutual funds. This allows investors to profit from intraday changes in price with relative ease.

ETF definition

Want to learn more?

Looking to continue your education? You can learn more about ETFs by visiting our ETF Centre.

TMX Money makes it easy to find the right ETF for your portfolio: visit our ETF Screener tool, which allows you to filter ETFs by asset class, region, style, size, sector, issuer, and more.

Stay tuned for future posts on stock market basics from TMX Money, the official financial portal of the Toronto Stock Exchange and the TSX Venture Exchange.

For questions about this article, please email tmxmoney@tmx.com.

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