A market ETF is an investment fund filled with investments in different securities that are designed to mimic the performance of a specific stock exchange index. An index groups various securities that are linked either by some commonality and measures the average performance of all of the included securities. Unlike a mutual fund, the value of a market ETF depends upon the amount of investors buying or selling the fund. This type of ETF, or exchange-traded fund, allows investors to get exposure to a vast variety of securities for a relatively small price.
Many investors would like to build a portfolio consisting of diverse stocks that are varied in terms in size and scope. Such a portfolio can help to remove the risk that a few securities might not perform up to standards. But it can also be costly to achieve such diversity. A market ETF gives investors the chance to invest in a broad range of stocks without paying as heavy a price. It also allows them a bit more flexibility than a typical mutual fund, which is another one-stop investment choice for portfolio diversification.
Mutual funds generally require a heavy investment just to be involved. A market ETF can trade at much lower prices, which allows investors to get in and out easily and trade the fund just as if it were a stock. In fact, the price of an ETF is based on the trading activity of investors. This is in contrast to a mutual fund, which bases its value on the total net worth of all of the assets it contains.
In general, a market ETF concentrates its investments on the assets tracked by a specific market index. For example, an ETF devoted to a specific emerging market might invest in all of the stocks tracked by a corresponding index. Other exchange-traded funds cover much wider varieties of stocks. With just one investment, an investor can gain a significant amount of diversity, without paying the high management fees often attached to mutual funds.
It is common for the manager of a market ETF, who chooses which investments to make, to attempt to replicate a specific index with no variation. There are some cases, though, when a fund will try a more aggressive strategy. For example, a manager of a fund devoted to an index of technology stocks might decide to pick and choose among the stocks included in the index to get better performance. Since this type of fund is more actively managed than a common market fund, it might require higher management fees. An effectively managed fund can make up for these fees with the good performance of the assets contained, making the fund more valuable to investors.