What are Exchange Traded Funds (ETF) in Finance?


Not everybody would love to read this article to the end, but those who are willing to understand what these are and how they work, will take their time to read and comprehend this article to the end. Nevertheless, i was once confused, had no clue about what Exchange Traded Funds are until I decided to make further research on them.

Luckily for you today, I will make this article to be as detailed and short as possible, it is a good practice to first introduce the theoretical part becoming jumping off to the more practical examples.

In this article, I will try my best to explain why you should invest in ETFs and other things associated with it.

What Are Exchange Traded Funds (ETF)?

Exchanged Traded Funds (ETF) are most times called investment funds, which are traded on the Stock Exchange such as the New York Stock Exchange or The London Stock Exchange, just like any other assets in the Financial Markets.

READ: How to Invest In the Financial Market

ETF is considered to be a basket of stocks, index, commodities, Bonds etc. (which I will explain later). In 2013, ETF has become one of the most popular type of exchanged traded Products because of their low cost, tax policies and they can be traded just like any other financial assets.

How Does the ETF Works

The ETF owns asset’s which can range from financial instruments such as treasury Bills and Bond to commodity such as Gold, silver and platinum down to currencies, stocks, etc. These financial assets are then pooled together and are divided into shares and each shareholder owns a ownership of the Exchanged Traded Fund, so we have seen why they are traded in Stock Exchange around the world and why they are likened to be a pool or basket of stocks, index, commodities, Bonds etc..

It may interest you that, each ETF has a totally different structure based upon the residing country and each shareholder indirectly owns the assets of the ETF and which usually get shares of the profit such as dividends. Each shareholder is entitled to annual report of the performance of the ETF.

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History of ETFs

ETFsThe ETF came into existence in 1989, however, it short-lived after a law suit by the Chicago Mercantile Exchange and it suddenly stop it sales in the United States.

Shortly after, a similar product started in the Toronto Stock Exchange in 1990, it began to grow in popularity and the popularity prompted the American Stock Exchange to try to develop something similar that will be in accordance with the SEC regulation in the United State.

Nathen Most and Steven Bloom, under the direction of Ivers Riley, designed and developed “Standard & Poor Depository Receipts” which were introduced in January 1993 and became known as the SPDRs or Spiders. The fund became the largest ETF in the world. In May 1995, they introduced the Midcap SPDRS.

VISIT: What Are Shares in the Stock Market?

After that, many other financial institution stared there’s such as Barclay Global Investors, another financial institution called MSCI and others formed iShares MSCI Index Fund and ever since many others have entered into the market to establish theirs.

We have looked at what ETF are and how they came about, let’s now give a practical illustration on how this ETF works.

Practical 1

A young man called Williams, who is interested in the Financial Market and wants to invest at his young age, Williams is a bit confuse, he isn’t sure whether he should buy stocks or currency, still confused he meets his uncle who is a veteran investor. His uncle advised him to invest in ETFs.

William’s uncle explain how the ETF works. There is an ETF, which Williams wants to invest in, this ETF is run and managed by a lady called Rose.

Rose is the fund manager at the ETF and when Williams decide to invest, he buys a certain amount of shares in the ETF, buying such shares, he comes a shareholder and is entitled to receive dividends.

Since the ETF is liked like a public company listed on the Stock Exchange, Williams can buy and sell his shares any time he wants d whenever he chooses, cool right?


Practical 2

Let us assume that there are 3 friends, along with Williams making it a total of 4 people, who has $10,000 each. Individually these people do not have the financial power to invest deeply into the financial market, especially to buy large assets. Along with their tight schedule and lack of participation in the financial market.

They can decide to pool their $10,000 together and get a fund manager who will manage the money on their behalf. Combined, there money ($40,000) can be used to invest in the financial market.

ALSO READ: What Are Exchange Rates?

These people can then get shares (unit of ownerships) because their money is pooled together. The fund manager can still further and get more client money which will result in a larger pool of funds, thus resulting in an ETF which can be traded on the Stock market.


We have seen how the Exchange Trade Fund works using the two practical’s I have earlier given, though the stock market is risky, same goes to the ETF, it can appreciate in price which will mean more value to the shares you own in the ETF or it can depreciated in price will mean less value to the shares owned in the ETF, thus, creating profits or losses.

Investing in ETFs is one of the simplest and low cost way to invest and it is suitable for young and aspiring investors, but in choosing which ETF to invest in can be another topic entirely on its own.

I would love to hear from you please comment below and share with your friends and family if you find this article helpful.

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