**Definition**

Exchange-traded funds, commonly referred to as ETFs, share many similarities with mutual funds. They typically track the price of an asset (like gold) or a basket of assets (such as the S&P 500). As their name suggests, ETFs are traded on stock exchanges and can be bought and sold like stocks through a traditional brokerage account.

**Why are ETFs important?**

ETFs are very popular. In 2020, $7.74 trillion in assets worldwide were invested in ETFs, nearly six times the amount from a decade earlier. Thanks to the surge in interest in low-fee index investing, ETFs have given rise to an entirely new type of financial company: "robo-advisors" like Betterment and Wealthfront, which invest almost exclusively in ETFs.

Think of ETFs as cousins of stocks and mutual funds. While mutual funds have been around for nearly 100 years, ETFs only debuted in the U.S. in 1993, when State Street Capital launched an ETF mimicking the S&P 500 (nicknamed "the spider"), which is still traded today. With over $350 billion in assets under management, it remains the largest ETF available.

**How do ETFs work?**

Like individual stocks, ETFs are listed on exchanges such as the New York Stock Exchange, Nasdaq, and the Shanghai Stock Exchange. Just like stocks, their share prices fluctuate during trading hours – a major difference between ETFs and mutual funds. The net asset value (NAV) of mutual funds is typically priced once a day, often after exchanges close. ETFs often track the price movements of their components dynamically through buying and selling those components whenever the price of either starts to diverge.

Similar to mutual funds, most ETFs act as a "package" that encompasses many individual securities. This makes both mutual funds and ETFs naturally attractive ways for individual investors to diversify their portfolios by adding multiple stocks, bonds, or other types of investments with a single transaction.

**Comparing ETFs and mutual funds**

These two asset types are similar in many ways. But there are many interesting differences.

- Mutual funds may or may not require a specific minimum investment amount. On the other hand, ETFs are sold by the share or fractional share, offering a low barrier to entry.

- ETFs are issued by well-known companies like Vanguard and Schwab, but unlike mutual funds, they are generally not bought directly from the fund issuer but instead from another investor on the stock exchange.

- Due to being actively traded on the market, ETF prices can sometimes deviate from the value of their underlying investments. (However, ETFs generally tend to closely track the prices of the underlying assets.)

- Unlike many mutual funds, ETFs are often passively managed – meaning there isn't a fund manager sitting at a Bloomberg terminal deciding which stocks to add or remove from the fund. Instead, computer algorithms often conduct ETF trades. Since fund managers don't need to be paid, ETFs usually have lower operating costs and expense ratios compared to actively managed mutual funds.

Because mutual fund managers can trade large volumes of assets in and out of the fund, their funds can incur significant capital gains taxes – which can impact returns. ETFs often replicate the composition and weighting of existing indices – such as the S&P 500 for large-cap stocks, the Russell 2000 for small-cap stocks, or the Bloomberg Barclays US Treasury Bond Index.

ETFs can also be tied to the market of a single asset, like gold. A Bitcoin (BTC) ETF would be similar to such a fund.

**Specialized ETFs**

However, not all ETFs are passive. Take, for example, the famous ARK Innovation ETF (ARKK), which actively invests in companies that its manager, Cathie Wood, believes are disruptive, like Tesla. ETFs like this are not cheap – ARKK comes with an expense ratio of 0.75% (representing the portion of the fund's assets used for management and other operating expenses), making it nearly as expensive as holding popular mutual funds like Fidelity’s Magellan. Some other ETFs are essentially identical products to mutual funds offered by the same company. Vanguard, which revolutionized low-cost investing, offers both passively managed mutual funds and ETFs, both tracking the S&P 500. (Although their returns are almost identical, the ETF version may be more attractive as the mutual fund requires a minimum investment of $3,000.) While index-tracking ETFs are the most popular with individual investors, there are countless other types of ETFs, from sector ETFs (e.g., investing exclusively in technology companies) to "thematic" ETFs (such as an ETF that allows Catholics to invest only in companies adhering to guidelines set by a conference of U.S. bishops). And of course, there are many other exotic financial options, such as leveraged ETFs that magnify market gains and losses and inverse ETFs, designed to thrive while their underlying indices decline. Before investing in an ETF, you should review any materials published (usually on the ETF's website) to ensure you understand what you are buying. Consult a licensed investment advisor if you have any questions about your financial strategy.

Source: Coinbase