Duration: 5:06
Level: Intermediate

The Main Goals: Understand what an Exchange-Traded Fund is; Comprehend how they are different from Mutual Fund; Find out about trading cost transparency, tax efficiency, and expense ratios; and learn what an index is.

Contributed By: WisdomTree U.S.

Study Notes:

This first lesson covers:

  • Characteristics of an Exchange-Traded Fund (ETF)
  • How ETFs differ from mutual funds
  • Types of ETFs
  • Defining an index

What is an Exchange Traded Fund (ETF)?

An ETF is a 1940 Act exchange-traded investment wrapper that tracks a basket of securities very similar to a mutual fund, but it is traded on an exchange. While most ETFs are designed to replicate and track an index, some are not tracking an index and are actively managed. ETF investors do not interact directly with the ETF exchange company. They trade ETF shares on an exchange.

How does an ETF differ from a mutual fund?

Buying and selling ETFs
  • ETFs are traded on an exchange intraday
  • Mutual funds are traded through the mutual fund company
  • Mutual funds are traded once a day at Net Asset Value (NAV)
Transparency
  • ETF holdings are published on a daily basis, and they are transparent at all times
  • Mutual fund holdings are published on a quarterly basis, generally on a 30-day lag
Minimum investments
  • The minimum investment for an ETF is one share
  • The price of the ETF = the minimum investment
  • Mutual funds tend to have higher minimums depending on the share class
Transparency of trading costs
  • ETF trading costs are borne by each individual investor
  • The cost is transparent through the bid-ask spread that you see on exchange
  • Costs of trading for a mutual fund are borne by all investors as the trading costs are wrapped into the NAV each day
Tax efficiency
  • ETFs are more tax efficient because of the technology of the creation redemption mechanism
  • Mutual funds are less tax efficient because trading is done inside the fund by a portfolio manager
Expense ratios
  • ETFs generally tend to be less expensive vehicles
  • Mutual funds typically have higher expense ratios and vary depending on share class liquidity
  • ETFs have daily liquidity and they have intraday liquidity
  • As long as the exchange is open, you can trade in and out of the fund
  • With mutual funds you can get in and out one time a day at NAV

What is an index?

An index is a hypothetical portfolio of investment holdings representing a segment of the financial markets. They are typically a benchmark index such as the:

S&P 500

ACSI

MSCI World

DAX

Russell 2000 Small-Cap

You cannot invest directly into an index. You must use some other sort of vehicle that tracks that index, and that is initially how ETFs were designed. Today, most ETFs still track an index.

The difference between the ETF and the index in a perfect world is called “tracking error,” and the tracking error difference between the return of the index and the ETF will be that fund’s expense ratio.


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Disclosure: WisdomTree U.S.

Investors should carefully consider the investment objectives, risks, charges and expenses of the Funds before investing. U.S. investors only: To obtain a prospectus containing this and other important information, please call 866.909.WISE (9473) or click here to view or download a prospectus online. Read the prospectus carefully before you invest. There are risks involved with investing, including the possible loss of principal. Past performance does not guarantee future results.

You cannot invest directly in an index.

Foreign investing involves currency, political and economic risk. Funds focusing on a single country, sector and/or funds that emphasize investments in smaller companies may experience greater price volatility. Investments in emerging markets, real estate, currency, fixed income and alternative investments include additional risks. Due to the investment strategy of certain Funds, they may make higher capital gain distributions than other ETFs. Please see prospectus for discussion of risks.

WisdomTree Funds are distributed by Foreside Fund Services, LLC, in the U.S. only.

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Information posted on IBKR Campus that is provided by third-parties does NOT constitute a recommendation that you should contract for the services of that third party. Third-party participants who contribute to IBKR Campus are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.

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