Definition

An Exchange-Traded Fund (ETF) is a type of investment vehicle that tracks an index, sector, commodity, or other asset, but can be purchased or sold on a stock exchange the same way a regular stock can. Think of it as a basket of securities bundled into one convenient, tradeable package.

Analogy

Imagine you're buying a pre-made fruit basket instead of purchasing each fruit separately. With one purchase, you get a diversified selection of fruits, carefully chosen and packaged together. An ETF works the same way – instead of buying individual stocks or bonds, you get a pre-selected collection of investments in one transaction.

Little-Known Fact

The first ETF wasn't actually American – it was Canadian! The Toronto 35 Index Participation Units (TIPs), launched in 1990 on the Toronto Stock Exchange, predated the famous SPDR S&P 500 ETF (launched in 1993) by three years. However, the SPDR is often mistakenly credited as being the first ETF.

Action Step:

Create a "watchlist" of three different ETFs from completely different industries (for example: technology, healthcare, and real estate). Follow their performance for four weeks, paying special attention to how they react differently to market news. This will help you understand sector diversification and prepare you to make more informed investment choices.

Set a calendar reminder to review your watchlist every Friday afternoon, noting which sectors showed strength or weakness that week.

Bonus: ETFs vs. Mutual Funds

While there are several differences between ETFs and Mutual Funds in terms of management style, costs and tax efficiency, the most crucial distinction is that ETFs can be bought and sold on stock exchanges like regular stocks, while mutual funds can only be traded once per day after the market closes.