Investors define ETF in finance as Exchange Traded Fund. It is a listed fund with investable basket of assets. Like mutual funds, ETFs are managed by a fund manager with a predefined investment mandate (example). Unlike mutual funds which is priced once a day after the market has closed. Exchange traded funds can be traded throughout the day.
The most common type of ETF is market index tracker such as SPDR S&P 500 (SPY). There are also other different type of ETFs beside from market etfs such as:
- Sector specific ETF tracks particular sectors of the market such as SPDRS Energy Select (XLE). Sector ETFs looks to return on the stocks in the energy sector.
- Most investor define commodity ETFs as an ETF that holds the underlying physical commodity it tracks or the futures of the commodity that is traded on ETFs
- Inverse ETFs look to return the opposite the performance of the index it tracks. ProShares UltraShort (SDS) tracks the opposite return of the S&P 500 index.
- The last type of ETF is actively managed ETF. Actively managed ETF defines ETF in a different light. Where as index ETFs are passive exchange traded funds which tracks the index as closely as possible. Actively managed ETFs are like active mutual funds except the fund is traded on exchange and price continuously rather than once a day.
ETF sit across the risk spectrum of investment options for investors. Where government bond and market index ETF can be considered low risk while at the opposing end the higher risk and return ETF include example such as emerging market or high yield ETFs (see our post on the best high yield ETF).