ETFs: hundreds of companies in a single purchase
An ETF is a fund that trades on the exchange as if it were a stock. With a single purchase you get a basket of companies or bonds, with low fees.
An ETF (Exchange Traded Fund) is an investment fund that's bought and sold on the exchange just like a stock. Instead of being a part of one company, each unit of an ETF represents a part of a basket: it can be the 500 largest U.S. companies, government bonds, gold or the companies in a sector.
Why they became so popular
- Instant diversification: with one purchase you own hundreds of companies.
- Low fees: many index ETFs charge less than 0.10% a year.
- Transparency: they publish what they hold, often every day.
- Ease: they're bought at any brokerage, and in Mexico many are on the SIC.
How it works inside
Most ETFs are passive: they don't try to pick the best stocks, but to copy an index (such as the S&P 500). If a company weighs 7% in the index, it weighs roughly 7% in the ETF. There are also active ETFs, where a team picks the investments, and they usually charge more.
An ETF's price moves during the day with the value of its holdings. Specialized institutions create and redeem units so the ETF's price stays very close to the value of what it holds.
The annual fee (expense ratio)
Each ETF charges an annual fee that's deducted little by little from the fund's value; you don't get a separate bill. It looks small, but over decades it weighs a lot.
Types of ETFs
| Type | What's inside | Examples of what they track |
|---|---|---|
| Broad market | Hundreds or thousands of companies | S&P 500, total U.S. market, world |
| Countries or regions | Companies from one country or region | Mexico, emerging markets, Europe |
| Sectors | Companies in one industry | Technology, health care, energy |
| Bonds | Government or corporate bonds | Treasuries, corporate bonds |
| Commodities | Gold, silver or others | Gold price |
| Thematic | Companies in a trend | Artificial intelligence, clean energy |
| Leveraged and inverse | Derivatives to multiply or invert the daily move | 2x or 3x an index |
Accumulating or distributing
Some ETFs pay out the dividends of the companies they hold (distributing) and others reinvest them automatically (accumulating). The latter are convenient for the long term; the former for those who want income. The difference can also change how you pay taxes.
ETF or individual stocks
It's not one or the other. Many people use broad ETFs as the core of their portfolio and, if they're interested, add some individual stocks they research thoroughly. With an ETF you won't beat the market, but you won't fall far behind it either.
Test what you learned
1. What is an ETF?
- A bank loan
- A fund that trades on the exchange like a stock
- A cryptocurrency
Show the answer
A fund that trades on the exchange like a stock. It's bought and sold on the exchange and holds a basket inside.
2. What does a passive ETF do?
- Picks the best stocks every day
- Copies an index
- Invests only in cash
Show the answer
Copies an index. It replicates the makeup of an index like the S&P 500.
3. What time frame are 3x leveraged ETFs designed for?
- Very short term
- Retirement
- The emergency fund
Show the answer
Very short term. They reset every day and can lose value over long, choppy periods.
Track your progress in ARCO
With a free account you save the lessons you finish, your streak and your achievements, and answer the question of the day.
Everything in this section is educational: it explains how investing works, it doesn't tell you what to buy.