What Are Exchange-Traded Funds (ETFs)?

Picking stocks can be overwhelming, especially if you’re new to investing. Other than investing in popular companies like Apple or NVIDIA, how do you know which stocks to add to your portfolio?

An exchange-traded fund (ETF) takes some of the guesswork out of picking stocks. They're an affordable way to invest in several different companies, without needing a ton of money upfront.

What Is an ETF?

An ETF, or exchange-traded fund, is a security you can buy or sell on the stock exchange, just like a stock or a bond.

But instead of representing an individual security, like a share of a company, an ETF represents a basket of different securities. By bundling several assets into one security, an ETF makes investing more accessible — you can invest in a fraction of something rather than owning it outright.

Many ETFs track indexes or specific sectors, like the S&P 500. For example, the SPDR S&P 500 ETF (SPY) holds shares of companies like Apple, Amazon, Microsoft, and Tesla in the fund, and resells those shares to investors. 

ETFs are a good entry point for investors because they have relatively low fees and allow you to diversify your risk across hundreds of companies rather than betting on just a handful to perform well.

The most well-known ETFs hold stocks, but others hold bonds, commodities, and even alternative assets like crypto.

How Do ETFs Work? 

ETFs are created by broker-dealers. Each broker-dealer has its own approach to selecting which companies will be included and how they are allocated in the ETF’s portfolio. Many follow benchmark index funds or create ETFs for specific industries.

Once an ETF is created, its shares are sold to investors. But you don’t own the underlying asset. For example, an investor in SPY would own SPY, not the shares of Tesla or Amazon that SPY is invested in.

But you'll still benefit from assets that appreciate in value, and if there is a dividend, you'll be able to earn that too.

ETF fees

ETFs generate revenue by charging a fee, called the expense ratio. It's typically an annual percentage of the ETF's value.

Well-known ETFs like the Vanguard S&P 500 ETF charge a small expense ratio of about 0.03%. The expense ratio is typically cheaper than paying a financial advisor for active portfolio management, but keep in mind that ETF fees can add up over time.

How to trade ETFs

Just like stocks, you can buy and sell ETFs on the stock market during normal trading hours. The best way to purchase an ETF is through a brokerage account.

Erika recommends Webull because it offers commission-free trading on a wide range of investment products, including ETFs, and it is very user-friendly.

Other reputable brokerage accounts include M1, Charles Schwab and Robinhood.

RELATED: How To Start Investing

Types of ETFs

You have several ETF options to choose from, so you can create a balanced portfolio:

• Index ETFs are designed to follow a specific index, such as the S&P 500. For instance, the S&P 500 includes the 500 largest companies in the U.S. economy.
• Fixed-income ETFs track the performance of fixed-income assets like U.S. Treasurys and other types of bonds. Bond ETFs can help mitigate risk when the stock market is down.
• Industry-specific ETFs track specific companies, usually grouped within a sector. These include healthcare, aerospace, or defense. 
• Commodities ETFs include commodities like gold and coffee. These can mitigate risks in other markets.
• Alternative investment ETFs include new assets like cryptocurrencies.

These are some of the most well-known ETF types, but there are others you can choose from to diversify even further.

For example, there are ETFs for exposure to foreign markets and ETFs designed to increase returns, such as leveraged ETFs.

Pros and Cons of ETFs

There are many reasons why you might want to consider adding ETFs to your investment portfolio, but there are also trade-offs to consider.

Pros	Cons
Access to a variety of companies in different sectors and sizes	You don’t own the underlying asset within the fund
Ability to manage risk by diversifying your investments	ETFs focused on a single sector can amplify risks within that industry
Lower fees than other types of funds or actively managed portfolios	Not all ETFs are passive — actively managed ETFs can come with higher fees
Ability to trade ETFs like stocks throughout the day	There can be a lag time in trading, which might make it difficult to jump on market fluctuations

ETFs vs. Mutual Funds

ETFs are similar to mutual funds in that they pool groups of securities together. But there are some key differences.

Cost

ETFs are a bit more cost-effective than mutual funds. They have lower fees, and there isn’t a minimum requirement to get started.

The Vanguard 500 Index Fund Admiral Shares is the mutual fund equivalent to the Vanguard S&P 500 ETF. Both track the S&P 500, but the mutual fund has a $3,000 investment minimum and charges a slightly higher expense ratio of 0.04%.

Ease of trade

ETFs are also easier to trade than mutual funds. Mutual funds aren’t listed on exchanges like the New York Stock Exchange. They are only traded once a day, usually at the end of the trading day.

That means you can’t do quick trades throughout the day as the market changes.

Support

Depending on your investment strategy, mutual funds might be more appealing. They're hands-off for you, since the burden of providing a high-quality product falls on the fund manager’s shoulders.

And if you have questions, fund managers are usually a phone call away (and willing to assist you if it means earning your business!). In this way, they offer more support than an ETF.

ETFs vs. Stocks

ETFs can easily get confused with stocks. Both are listed on the stock exchange, and both can be traded throughout the day. But otherwise, they are very different investments.

Ownership

A stock is a share of a company. For example, when you buy Tesla stock, you are purchasing a share of ownership in Tesla.

An ETF represents a bundle of different companies, rather than a share of a single company. That means when you buy an ETF, you’re owning a fraction of a company’s share, rather than the entire thing outright.

ETFs mitigate some of the risks involved in picking stocks, but it doesn’t eliminate the risk completely. 

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Governance privileges

Being a shareholder comes with privileges, like being able to vote at the annual company meeting. Warren Buffet’s annual shareholder meeting for his company, Berkshire Hathaway, is a major event. Many people own shares of Berkshire Hathaway just to go to the annual shareholder meeting!

But owning an ETF with Berkshire Hathaway in it isn’t the same as owning a share of Berkshire Hathaway directly. You won’t be considered a shareholder because the ETF fund provider owns the underlying asset, not you.

That means even though ETF investors receive some of the financial benefits, they won't have a say in how the company is governed.

Cost

Another key difference is the fees. While some brokerage firms may charge a fee for trades, most have eliminated that. Holding stocks in a brokerage account is typically fee-free, except when managed by an advisor.

ETFs charge an annual fee represented as the expense ratio. Even though ETFs are passively managed, fund managers still charge a fee for operating them.

RELATED: 3 Ways to Buy and Sell Stocks in Your Portfolio

FAQs

TL;DR: How To Invest With ETFs

ETFs let you invest in a bundle of companies all at once, which spreads out your risk without needing thousands of dollars upfront. You don't actually own the individual stocks inside the ETF, but you still benefit from their growth and any dividends they pay out.

They're perfect if you're starting out or want to diversify without picking individual stocks. You can buy them through most brokerage accounts, including investing apps such as Webull or M1, during normal trading hours.

Just remember that while ETFs are generally safer than betting on single stocks, they're not risk-free — especially sector-specific ones that can be hit by industry downturns.

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View M1 disclosures. M1 Finance, LLC does not charge commission, trading, or management fees for self-directed brokerage accounts. You may still be charged other fees such as M1’s platform fee, regulatory fees, account closure fees, or ADR fees. For a complete list of fees M1 may charge visit M1 Fee Schedule.