Definition of ETF: Just What Is An ETF?

Exchange Trade Funds (ETFs) are very much like mutual funds. That is, they are baskets of stock that are bought and sold. They differ from mutual funds in that shares of ETFs can be traded at any time while the host stock market is open. This added flexibility has one drawback in that to trade an ETF, you incur a broker fee.

ETFs then are best traded in relatively large batches that keep the trading fee to a very small percentage or fraction of a percentage of the total cost. They are ideal for picking up stocks when there's an irrational dip in prices since an order can be placed in real-time.

Many ETFs are based on an index making them exchange traded index funds. An index fund is a passively managed collection of stocks that represent a particular region, sector, or asset class. One of the more common index funds is one that closely matches the holdings and performance of the S&P 500. Other common index funds match the S&P 400 (mid-cap) and S&P 600 (small-cap).

However, since the initial launch of ETFs, there has been an explosion of index ETF offerings. It is now possible to index countries and not just regions. It is also possible to index silver, gold, oil, and commodities. Some say there are now too many players in the index ETF field and they're probably right. I recommend sticking with the big players such as Barclay's iShares, PowerShares, or State Street's StreetTracks if they have the ETF of interest.

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