An exchange-traded fund, or ETF, is a pooled investment fund whose shares are listed on a stock exchange and change hands all day at market prices, like shares of a company. Behind every share sits a basket of securities, and a small group of large dealers can swap that basket for newly issued ETF shares, or hand shares back for the basket. That two-way door ties the trading price to the value of the holdings. The SEC approved the first ETF in 1992, and the SPDR S&P 500 ETF Trust (SPY) began trading in January 1993. By the end of 2025, 4,495 US ETFs held $13.4 trillion, according to the Investment Company Institute (ICI). For how ETFs fit into stock investing more broadly, start at the stocks hub.
What does an ETF actually own?
An ETF owns whatever its prospectus says it will: usually stocks or bonds, sometimes commodities or futures, held in one portfolio for all its shareholders. Each share is a proportional claim on that portfolio and its income, so one share of an S&P 500 ETF is a sliver of roughly 500 large US companies in their index weights.
The fund values the portfolio every business day. Net asset value (NAV) per share is the market value of everything the fund owns, minus what it owes, divided by the shares outstanding. On October 29, 2026, SPY's NAV was $769.51 a share across about 1.06 billion shares, for total assets of $813.6 billion.
Most ETFs follow an index. Actively managed ETFs held just 11.1% of ETF assets at the end of 2025, ICI reports. How index funds choose and weight what they hold is covered in index funds explained.
How are ETF shares created and redeemed?
New ETF shares are created when an authorized participant delivers a basket of securities to the fund, and they disappear when it hands shares back for the basket.
An authorized participant, or AP, is a clearing firm, typically a large broker-dealer, with an agreement that lets it place orders directly with the fund. Everyone else trades existing shares with one another on the exchange. The fund issues and cancels shares only in large blocks called creation units. Using SPY's published terms, a creation works like this:
- Each business day the fund announces the basket it will accept: securities and quantities that mirror its portfolio, plus a small cash amount to square the basket's value with NAV.
- The AP assembles the basket, buying the stocks or drawing on inventory, and delivers it to the fund with a transaction fee.
- The fund issues one creation unit, which for SPY is 50,000 shares, worth about $38.5 million at the October 29, 2026 NAV.
- The AP can keep the shares or sell them on the exchange.
A redemption runs the same steps backward: the AP returns 50,000 SPY shares to the trust and receives the basket of stocks. SPY's trustee charges the lesser of $3,000 or 0.10% of a creation unit's value per participating party per day, currently $3,000.
Because the exchange is in kind, securities for shares, the fund rarely has to sell stocks to pay departing investors. That has tax consequences, and ETFs vs mutual funds vs index funds shows how much it cuts capital gains distributions.
Why does an ETF trade close to its net asset value?
An ETF trades close to its NAV because authorized participants profit from any meaningful gap by creating or redeeming shares, and their trading closes it.
If the market price rises above the value of the holdings, a premium, an AP can buy the cheaper stocks, exchange them for new ETF shares and sell those at the higher price; the extra supply pushes the price back down. If the price falls below NAV, a discount, the AP buys the cheap ETF shares, redeems them for the more valuable basket and sells the stocks. The SEC's investor bulletin credits this arbitrage for letting retail investors usually buy close to NAV.
Worked example: Why even a 0.05% premium on SPY is worth closing
Take one SPY creation unit at the October 29, 2026 NAV, and suppose the shares briefly trade 0.05% above that value.
- Value of the basket an AP delivers: 50,000 × $769.51 = $38,475,500
- Value of the 50,000 new shares at a 0.05% premium: $38,475,500 × 1.0005 = $38,494,738
- Gap captured by creating and selling: $19,238
- Less SPY's $3,000 transaction fee: $16,238, before the cost of buying the stocks and hedging during the trade
- Premium needed just to cover the fee: $3,000 ÷ $38,475,500 = about 0.008%
APs also carry trading costs and market risk until settlement, but a fixed fee spread over a $38 million block is tiny, which is why heavily traded stock ETFs rarely stray far from NAV.
The disclosures bear this out. In 2025, SPY's closing price was above NAV on 123 trading days and below it on 127, and its premium or discount on October 29, 2026 rounded to 0.00%.
The mechanism has limits. Prospectuses warn that APs have no obligation to create or redeem, and if they step back, an ETF can trade at a wider gap to NAV with wider bid-ask spreads. That risk is greatest for funds whose holdings are hard to trade, such as some bond and foreign-stock ETFs in a sell-off.
What did the SEC's 2019 ETF rule change?
Rule 6c-11, effective December 23, 2019, let most ETFs launch under one standard rule instead of first obtaining their own exemptive order from the SEC.
ETFs never fit neatly into the Investment Company Act of 1940, which assumed investors would buy from and sell back to the fund at NAV, so each one needed individual permission. The SEC had issued about 300 such orders since 1992, with conditions that varied by sponsor. When the rule was adopted, ETFs held $3.32 trillion, about 16% of investment company assets; by 2025 their share had reached 30%.
In exchange for standard treatment, an ETF relying on the rule must post on its website each business day, free of charge:
- its full portfolio holdings, before the market opens
- the prior day's NAV, market price and premium or discount
- a table and a line graph of premiums and discounts for the last calendar year and the quarters since
- its median bid-ask spread over the last 30 calendar days, measured from quotes taken every 10 seconds
- an explanation whenever its premium or discount exceeds 2% for more than seven trading days in a row
A few designs stayed outside the rule, including unit investment trusts such as SPY, share-class ETFs and non-transparent ETFs, which kept relying on their own orders. For investors, those daily pages show what a fund really costs to trade: a 0.01% median spread is far cheaper than 0.50%.
What are ETF share classes of mutual funds?
An ETF share class is an exchange-traded class of an existing mutual fund, so ETF and mutual fund investors own one portfolio under different trading rules.
Vanguard has run funds this way for years. Its 500 Index Fund issues Admiral, Investor and Institutional Select mutual fund shares alongside an ETF class, VOO, launched in September 2010, all holding the same stocks. Other managers needed SEC permission to copy the design, which the 2019 rule did not cover. The SEC granted it to Dimensional Fund Advisors on November 17, 2025, and by March 17, 2026 it said it had issued multi-class ETF orders to more than 48 fund companies, with about 100 applications filed. On March 20, 2026, Dimensional listed what it called the industry's first actively managed share-class ETF, the US Micro Cap ETF (DFMC), a class of a mutual fund it launched in 1981.
Dimensional says its mutual fund shareholders can gain lower trading costs and better tax efficiency, and its ETF holders more efficient rebalancing. The SEC has noted the catch: in-kind ETF trading and cash mutual fund trading can generate different costs for the shared portfolio, and all shareholders generally bear them.
How much does an ETF cost to own?
The main cost is the expense ratio, an annual percentage of assets taken from the fund itself, plus the trading costs you pay each time you buy or sell.
Nobody sends a bill: the SEC explains that funds pay operating expenses out of fund assets, which lowers the value of every share. SPY's expense ratio of 0.0945% is the sum of a 0.0492% trustee fee, a 0.0301% S&P license fee, 0.0132% for marketing and 0.0020% for other expenses, about $9.45 a year on a $10,000 holding.
The ratio leaves out commissions, the bid-ask spread, any premium or discount and the fund's own trading costs. Averages can mislead: in ICI's 2025 data, index equity ETFs charged 0.45% on a simple average but 0.14% weighted by assets, the better guide to what shareholders actually paid, because money gathers in the cheapest funds.
Worked example: What 0.03%, 0.20% and 0.75% cost on $10,000 over 30 years
Assume a single $10,000 investment earning 7% a year before costs, purely as an illustration. The expense ratio is subtracted from that return every year, so the money compounds at 6.97%, 6.80% or 6.25%.
| Expense ratio | Value after 30 years | Fees deducted along the way | Shortfall vs a fund with no costs |
|---|---|---|---|
| 0.03% | $75,485 | $282 | $638 |
| 0.20% | $71,968 | $1,823 | $4,155 |
| 0.75% | $61,641 | $6,197 | $14,482 |
- With no costs at all: $10,000 × 1.07³⁰ = $76,123
- At 0.75%: $10,000 × 1.0625³⁰ = $61,641, or 19% less than the cost-free result
- The shortfall is more than twice the fees themselves, because every dollar paid out also stops compounding
To test other amounts, subtract a fund's expense ratio from the return you enter in the compound interest calculator, and see how compound interest works for the formula behind it.
How can you check whether an ETF tracks its index?
Compare the fund's NAV return with its index return for the same periods; the shortfall, called tracking difference, should sit close to the expense ratio.
Fact sheets print both numbers side by side. For the 10 years to September 30, 2026, IVV returned 15.30% a year at NAV against 15.32% for the S&P 500, a gap of 0.02 percentage points, slightly smaller than its 0.03% fee. Lending income can offset part of a fund's costs, while idle cash, transaction costs and sampling can widen the gap, so a shortfall that runs well beyond the expense ratio year after year is a hidden cost. SPY vs VOO vs IVV runs the three largest S&P 500 ETFs through this test.
How do you buy and sell ETF shares?
You buy and sell ETF shares through a brokerage account while the market is open, exactly as you would a stock, using the fund's ticker symbol.
A few habits keep trading costs in check:
- Use a limit order, which caps the price you pay, rather than a market order, especially for thinly traded funds; stock order types explains the choices.
- Know the trading calendar, including early closes; stock market hours and holidays lists the schedule.
- Plan around settlement, which follows the stock timetable: One business day after the trade (T+1), since May 28, 2024.
- If the share price is high, check whether your broker sells fractional shares.
The SPY page charts the S&P 500 fund's price history, and the QQQ page does the same for the Nasdaq-100 fund.
What are the risks of owning an ETF?
An ETF carries the risks of whatever it holds, plus a few that come from trading on an exchange.
- Market risk. A stock ETF falls when its stocks fall. SPY's prospectus shows its worst quarter of the past 10 calendar years was a 19.60% drop in the first three months of 2020.
- Price gaps in stress. When markets seize up, the market price can fall well below NAV, and you sell at the market price.
- Concentration. An index ETF inherits its index's tilts: Vanguard's S&P 500 ETF had 40.6% of its assets in its ten largest holdings at the end of September 2026.
- Complex designs. Leveraged and inverse ETFs aim for a multiple or the inverse of an index's return over a set period, often a single day, so results over longer stretches can differ sharply from what the name suggests.
- No insurance against losses. ETF shares are not bank deposits. If a brokerage fails, SIPC protects missing securities and cash up to $500,000 per customer, including up to $250,000 in cash, but not declines in value; FDIC vs SIPC explains the difference.
Types of investment risk maps the wider ways investments lose money, and ETFs holding Treasury bills raise their own questions, covered in T-bill ETFs vs buying T-bills.