ETFs. Index funds. You’ve read about them in personal finance columns. You’ve heard they’re the investments you should own. And if you’re a Financial Zen client, you actually do own them. But really, what is an ETF?
Very simply, it’s a basket of related stocks. Related how? Let’s look at an example.
Take 500 of America’s largest companies – Apple, JP Morgan, Chevron, Kraft Heinz – and throw them in the same basket. That’s the Standard & Poor’s 500 basket (aka S&P 500 Index).
Then log into E*Trade and buy one share of each. Your portfolio would mimic the S&P 500 index.
But buying one share of 500 companies would be a complete pain in the butt. And expensive. They would charge you a $7 commission for each trade. That’s $3500.
Instead, you can just buy an S&P 500 ETF. Big financial institutions like Vanguard and iShares and Schwab have done all the work for you.
They bought a bunch of shares of all the companies in the S&P 500 and repackaged it into something you can purchase. If you buy one share of an S&P 500 ETF, you buy into fractional shares of all the companies in the S&P 500.
It’s like the cellophaned fruit at Safeway. You could collect all the fruit and slice it up yourself, or you can buy the fruit in the cellophane that has already been collected and sliced up for you.
Just like the fruit, you’ll pay a small premium to have someone else do the work for you. Most S&P 500 ETFs charge you about 0.10% per year.
So what is an ETF?
Prepackaged fruit.
