What are Exchange-Traded Funds?

In the stock market, there are multiple ways to seek out opportunities. Two common themes in investing are buying and selling individual securities or adhering to index investing, which is a way to take advantage of a prearranged index filled with securities of a like kind. By investing in exchange-traded funds, however, investors essentially are able to take advantage of both strategies. The process of investing in these funds is very similar to traditional investing and can be completed with a stock broker.

Exchange-traded funds (ETFs) are an investment vehicle in the stock market. These indexes are comprised of shares from multiple companies, they trade throughout the day in major stock markets around the world, and they are common in the United States. One exchange-traded fund can include shares of as few as 12 individual companies or as many as thousands of securities. These individual companies have some common theme connecting them, and this is what determines the index to which they belong. Similar to the way that stocks trade in the financial markets, exchange-traded funds are assigned a ticker symbol that is used to illustrate trading in that particular index.

There are different criteria that set one exchange traded fund apart from another. For instance, gold exchange-traded funds are comprised of companies that are in the gold business, as the name suggests. Many industries, such as energy, oil and technology, have their own indexes.

A benefit of these industry groupings is that investors can gain exposure to an entire region or industry without having to make the selection of one individual stock. As a result, an investor's portfolio becomes more diversified rather than just tied to the performance of a single stock's performance. A United States investor who is not familiar with individual securities in Asia can gain exposure to the region through an exchange-traded fund and bypass any disadvantage that might be associated with individual stock selection in a foreign market.

There also are tax advantages to exchange-traded funds. In the U.S., they are exposed to a lesser tax burden than that with which mutual fund investors must comply. Mutual funds are baskets of stocks across various industries and regions that are managed by a professional investor and into which individual investors invest. Mutual fund managers tend to trade more actively, buying and selling shares more frequently than is common with investing in exchange-traded funds.