ETF stands for Exchange-Traded Funds and refers to investment companies that sell large blocks of stocks to, generally, large institutional investors. First introduced in 1993, ETF shares track market indices or groups of stocks, rather than individual stocks. For example, the first ETF shares were referred to as SPDRs, or "Spiders," because they followed Standard and Poor's 500 index of large-company stocks.
Today, companies like Barclay's and Vanguard offer ETF shares that track everything from the entire U.S. stock market to more specific types of stocks, including shares in energy, utilities, technology and REIT (Real Estate Investment Trust) interests.
Other ETF shares will track investments in specific countries, commodities or just about any industry.
ETFs sell shares to investors in large blocks of stocks called "Creation Units," which are representative of a selected market index, industry, or sector of interest. Because Creation Units are not composed of individual stocks, ETF shares have the added benefit of being a diversified investment option.
Additionally, compared to other types of investments like mutual funds, ETF shares have much lower annual operating costs. But because ETF shares must be purchased from brokers, the fees for buying and selling can be significant for small investors. As a result, ETF shares are typically better suited for larger investors looking to invest significant amounts of money.
ETF shares differ from more traditional types of investments in several ways.
For example, instead of paying in cash as one might for individual stocks, investors typically purchase ETF shares with securities that mirror the ETFs' portfolio. ETFs typically redeem their shares by paying investors with securities that comprise the company's portfolio, rather than cash.
Once a purchaser has acquired ETF shares, that person or institution may decide to split up and sell the individual shares on a secondary market or ultimately sell the Creation Units back to the ETF.