Exchange Traded Funds, commonly known as ETFs, are like mutual funds in the sense that the money from various investors is pooled to buy a basket of investments that trade as shares on the stock exchanges, unlike mutual funds which are not traded on the stock exchanges.
Thus, you can buy and sell ETFs on the stock exchanges, where they are listed, in market transactions just like stocks or shares of a company. Also, the price of an ETF fluctuates during the day depending on the price fluctuations of the underlying investments and a variety of other factors like the news of the day, currency fluctuations, global events etc., unlike a mutual fund whose price is declared at the end of the day as Net Asset Value or NAV. Thus, a gold ETF’s price may fluctuate during the day based on the price of gold, the price of the shares of gold companies that may be part of the ETF, and a variety of other factors that affect gold prices, earnings of gold companies, and thus such gold ETFs.
Unlike the high expense ratios, or management fees, of mutual funds, ETFs charge very low fees, as low as 0.05% or lower which is 95% lower than the fees charged by a mutual fund, which may charge 1% or higher. Thus, ETFs are considered low cost investments in terms of fees.
ETFs can be index-based or actively managed ETFs.
Index-based ETFs seek to track a market index, and hold investments in a similar proportion to the holdings that make up that market index. So the ETF with the symbol SPY, which tracks the S&P 500 Index, holds investments that replicate as closely possible the investments that make up the S&P 500 Index’s holdings. So, if the S&P 500 Index held shares of companies A and B in the proportion 40% & 60% respectively, then SPY also holds nearly 40% of company A’s shares and 60% of company B’s shares. Index-based ETFs only change their holdings when the index they are replicating undergoes a change in its holdings. This low turnover in investment holdings leads to very low costs for the index-based ETF, which is transferred to the investor in the form of low ETF fees.
Actively managed ETFs, on the other hand, don’t seek to replicate an index, but contain a basket of investments in stocks, bonds, and other assets to achieve an investment or returns objective (low risk, high dividend, emerging market etc) as stated in its prospectus. By their very nature, these ETFs are actively managed thereby incurring higher transaction costs (to achieve their state objectives) as compared to the index-based ETFs, and hence should be expected to have higher fees than index-based ETFs.
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