ETFs. Exchange Traded Funds. 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 member, 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 your brokerage account and buy one share of each. Your portfolio would mimic the S&P 500 index. (-ish. It’s not exactly one share of each, but let’s roll with it for the concept.)
But buying one share of 500 companies would be a complete pain in the butt. And expensive.
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 cheese plate at Safeway. You could collect all the cheese and meats and crackers yourself, or you can buy the cheese plate in the plastic container that’s already been collected and sliced up for you.
Just like the cheese plate, 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’s an ETF?
A cheese plate.
