ETF stands for "Exchange-Traded Fund," which is a type of open-end fund listed and traded on an exchange, with trading procedures identical to stocks.

As an index fund, an ETF also tracks the components of an index for investment. The assets managed by an ETF consist of a basket of stocks, often matching the stocks of companies included in a specific index. The ETF purchases a portion of each stock and discloses its investment structure, i.e., the proportion of shares bought in individual companies. The trading price of an ETF depends on the value of its stock portfolio, known as the "Net Asset Value (NAV) per unit."

How It Works

In general, the fund company first purchases various stocks (potentially all the stocks in an index) to form a large fund. These stocks are then divided into smaller units and allocated to each investor who buys the ETF. By purchasing the ETF, investors effectively buy all the stocks in the index. Since ETFs typically track major market indices or blue-chip companies, their returns are relatively stable.

ETFs are a hybrid type of special fund, combining the advantages of both closed-end and open-end funds. This does not mean that ETF index funds can be subscribed or redeemed at any time like open-end funds. Instead, ETFs can be traded on the market, and their shares can be created or redeemed using a basket of index components.

Due to their simple and easy-to-understand concept, as well as their investment in stable blue-chip companies with steady returns, ETFs are widely accepted.

ETFs possess characteristics of both closed-end funds and stocks, making them a type of closed-end fund tradable on the secondary market. Their trading price on the secondary market reflects real-time market prices, which may differ from the ETF's actual NAV.

Advantages of ETFs

In the U.S. stock market, ETFs are favored for their tax benefits and low fees (lower trading costs and management expenses). From 1993 to 2015, over $2 trillion was invested in ETFs. By the end of 2015, ETFs had essentially covered all possible investment fields and adopted nearly all possible investment strategies.

Here, we mainly discuss the fee advantage of ETFs. Low fees are a key factor distinguishing ETFs from traditional mutual funds and attracting investors. This fee advantage stems from two aspects: most ETFs are index funds, and ETFs have structural advantages. Index funds are relatively easier to operate because they do not require stock selection and can largely rely on computerized trading. ETFs not only have lower shareholder-related costs but also do not need to maintain large cash reserves to prevent liquidation and redemptions. Typically, mutual funds charge fees between 1% and 3%, while ETFs charge less than 1%. Over the long term, this fee difference can significantly impact investor returns.