What is an ETF?
An ETF (Exchange-Traded Fund) is a basket of securities - stocks, bonds, or other assets - that trades on an exchange just like a regular stock. When you buy one share of an S&P 500 ETF, you instantly own a piece of all 500 companies in the index.
Most ETFs are passively managed, meaning they simply track an index rather than trying to beat it. This results in lower fees and, historically, better performance than most actively managed funds.
Instant Diversification
A single share of VTI (Vanguard Total Stock Market ETF) gives you exposure to over 4,000 US stocks. One purchase, complete diversification. No need to pick individual winners.
Why ETFs Are Popular
- Low costs: Expense ratios as low as 0.03% (vs 1%+ for active funds)
- Diversification: Own hundreds or thousands of stocks in one fund
- Simplicity: Trade like stocks, buy/sell anytime market is open
- Tax efficiency: Lower capital gains distributions than mutual funds
- Transparency: Holdings disclosed daily
ETFs vs Mutual Funds
ETFs
- Trade throughout the day
- Real-time pricing
- Lower expense ratios (typically)
- No minimum investment
- More tax efficient
- Commission-free at most brokers
Mutual Funds
- Trade once daily at market close
- NAV pricing only
- Often higher fees
- May have $1,000-$3,000 minimums
- Can trigger capital gains distributions
- Automatic investing easier
How to Choose ETFs
Key Metrics to Evaluate
- Expense Ratio: Annual fee as a percentage of assets. Lower is better. A 0.03% fund costs $3/year per $10,000 invested.
- Assets Under Management (AUM): Larger funds tend to be more liquid and have tighter bid-ask spreads.
- Tracking Error: How closely the ETF follows its index. Should be minimal.
- Bid-Ask Spread: The difference between buy and sell prices. Smaller is better.
Expense Ratios Compound
A 1% expense ratio might not sound like much, but over 30 years it can cost you 25% of your final portfolio value. The difference between 0.03% and 1.00% on $100,000 over 30 years is over $100,000 in lost returns.
Popular ETFs by Category
| Category | ETF | Expense Ratio | What It Tracks |
|---|---|---|---|
| US Total Market | VTI | 0.03% | Entire US stock market (4,000+ stocks) |
| S&P 500 | VOO / SPY | 0.03% / 0.09% | 500 largest US companies |
| International | VXUS | 0.07% | All non-US stocks |
| Total Bond | BND | 0.03% | US investment-grade bonds |
| Total World | VT | 0.07% | Global stocks (US + International) |
| Growth | VUG | 0.04% | US large-cap growth stocks |
| Dividend | VYM | 0.06% | High-dividend US stocks |
Building an ETF Portfolio
You don't need dozens of ETFs. A simple 2-3 fund portfolio can provide complete diversification.
Example: 3-Fund Portfolio
The Bogleheads 3-Fund Portfolio
This simple approach - total US stock, total international, total bond - has outperformed most professional investors over the long term. Learn more in our Bogleheads guide.
Common ETF Investing Mistakes
- Over-diversifying: Owning 15 overlapping ETFs doesn't help - 3 is often enough
- Chasing performance: Last year's top performer rarely repeats
- Ignoring expense ratios: Small differences compound to huge amounts
- Trading too often: ETF liquidity makes it tempting, but patience wins
- Neglecting rebalancing: Annual rebalancing maintains your target allocation
Frequently Asked Questions
Track Your ETF Portfolio
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