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WalletPrep worksheet · Investing

What is an ETF, and how does it work?

Name ____________________ Date __________

Key ideas

  1. An ETF is a fund trading like a stock. You buy and sell shares during the day at the market price, through a brokerage account or an IRA.
  2. What it holds matters more than the label. A broad index ETF spreads your money widely. A narrow theme ETF or a 2x fund can be far riskier.
  3. You pay a yearly fee plus a small spread. The expense ratio comes out every year. The bid-ask spread is a small hidden cost each time you trade.

Vocabulary

ETF
Exchange-traded fund: a basket of investments that trades on a stock exchange throughout the day, like a single stock.
Stock
A small piece of ownership in a company. Its price rises and falls with how investors value the business.
Brokerage account
An investment account where you can buy and sell stocks, bonds, ETFs and mutual funds. It has no special tax benefits.
IRA
Individual retirement account: a tax-advantaged retirement account you open yourself at a bank or brokerage, separate from your job.
Bond
A loan you make to a government or company. It pays you interest and returns your money on a set date, called the maturity date.
Index fund
A mutual fund or ETF that tries to match a market index by holding the investments in it, rather than picking winners.

Work it out

Dana, 26, opened a Roth IRA and moved in $1,000. She picks a broad US stock index ETF trading at $80 a share, with a 0.03% expense ratio. Her brokerage sells whole shares only.

  1. Cash in the account
  2. 12 shares at $80
  3. Left in cash
  4. Invested in the ETF
  5. Yearly fee at 0.03%
  6. Spread cost, 12 shares

Check yourself

  1. What is the main way an ETF differs from a mutual fund?

    • A. An ETF holds only one company
    • B. An ETF trades on an exchange during the day at a market price
    • C. An ETF has no fees
    • D. An ETF cannot lose value

  2. An ETF trades at $50 a share. How many whole shares does $430 buy?

    • A. 6
    • B. 8
    • C. 9

  3. Which ETF is most likely to drift away from its index over many months?

    • A. A broad total stock market ETF
    • B. A broad bond index ETF
    • C. A 3x daily fund that tries to triple the index's daily move

Your turn

Look up one broad index ETF available in your IRA or brokerage account. Write down its expense ratio, its number of holdings and its top 10 holdings. If it charges more than about 0.20% for a broad fund, compare it with one or two others.

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Answer key

What is an ETF, and how does it work?

Work it out

  1. Cash in the account$1,000
  2. 12 shares at $80− $960
  3. Left in cash= $40
  4. Invested in the ETF$960
  5. Yearly fee at 0.03%$0.29
  6. Spread cost, 12 shares$0.48
  1. $1,000 ÷ $80 = 12.5, so whole shares mean 12 shares. 12 × $80 = $960, leaving $1,000 − $960 = $40 in cash for next month's purchase.
  2. The yearly fee is $960 × 0.03% = about $0.29. At a 1% fee, the same holding would cost $9.60 a year.
  3. With a 4-cent spread, buying and later selling 12 shares costs about 12 × $0.04 = $0.48 in total. Holding for years keeps that cost tiny.

Check yourself

  1. B. An ETF trades on an exchange during the day at a market price ETF shares trade all day on an exchange. A mutual fund trades once a day at its closing NAV. Both can hold many investments, charge fees and lose value.
  2. B. 8 $430 ÷ $50 = 8.6, so you can buy 8 whole shares for 8 × $50 = $400 and keep $30 in cash.
  3. C. A 3x daily fund that tries to triple the index's daily move Funds that multiply a daily move reset every day, so over longer periods their results can differ sharply from 3 times the index's return.