The Importance of ETFs Wednesday, November 19, 2:19 PM ET
"ETF" stands for Exchange Traded Fund. ETFs trade on an exchange just like stocks, but instead of "shares" investors are actually buying and selling "units." These units can be traded back and forth just like stocks, but a big difference is that units can also be created or destroyed to accommodate investor demand. Another type of fund called a "CEF" -- which stands for Closed End Fund -- has a steady number of shares that does not change on a day to day basis.
This difference between ETFs and CEFs means that generally speaking, ETFs tend to trade extremely close to the underlying net asset value of the fund, whereas the price of a share of a CEF can move dramatically above or below the underlying net asset value of the fund, all depending on the supply of shares and the level of investor demand.
But unlike CEFs that typically have a well-paid manager making decisions about how to invest the fund's assets, ETFs by comparison typically take out all of the decision-making and instead blindly follow an underlying index or formula. That underlying index can be anything from the S&P 500, to an index of investment grade bonds, to gold, to emerging markets, and everything in between. By taking out the decision-making and simply following an index, ETFs are able to charge a very low fee as a percentage of net assets, helping drive their popularity among investors.
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