What is an ETF?

An ETF, or Exchange-Traded Fund, holds dozens and even hundreds of stocks, commodities, or bonds, giving you the safety of diversification and exposure to many different types of investments.

Like most investments, an ETF comes with advantages and disadvantages for any given investor. ETFs allow small investors to buy a piece of their favorite asset groups more cheaply and with less hassle than buying a traditional mutual fund or multiple stocks. ETFs can also be used to track the progress of the leading indexes, which is why even professional traders and hedge fund managers have come to prefer them over individual stocks and commodities.

Like stocks, an ETF can also be aggressive, defensive, growth-oriented, or based around different sectors like clean energy or dividend investments. ETFs also offer investors another key advantage: they make it easier to see at a glance which industries are outperforming and which ones are underperforming the broad market. 

When you’re trying to decide which ETFs are likely to return a worthwhile profit, one of the best things you can do is perform a quick relative performance check. This is done by comparing the fund’s recent price performance against the performance of a benchmark index, such as the S&P 500. 

But there are downsides to ETF investing. Anyone who was investing in stocks in 2008 can probably remember the deepening feeling in the pit of their stomach as the market continued the free-fall that began in earnest in January 2008 and would continue through March 2009. During that time, the S&P 500 Index fell nearly 58% in the most popular broad market index in the U.S. If you were holding index ETFs, you really suffered.

There are some instances when investing in ETFs makes sense—whether it be gaining maximum exposure to a red-hot sector, gaining access to an entire country’s stock market, or simply taking advantage of a bull market. In general, however, we don’t recommend buying and holding ETFs the way you would stocks with long-term growth potential.

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