What is an ETF?

      An ETF is a collection of stocks or bonds or other securities. In general, the choice of the securities is designed such that the ETF matches the change in value of an Index that has been devised to represent some specific aspect of the securities market.

     One example of an Index is the famous Dow Jones Industrial Average (DJIA). This average consists of 30 large US companies chose because the supposedly represent the core of American Industry. There is an ETF called DIA which has the investment goal of emulating the price performance of the DJIA. The managers of DIA (State Street Bank) buy shares of each of the 30 companies in the DJIA in the same proportion that they are represented in the DJIA. If you buy a share of DIA you actually own a fraction of a share of each of the companies in the DJIA.

     You buy shares of DIA through a broker, and the broker, in turn, buys the shares of DIA that you order on a stock exchange. As new shares of DIA are bought (or sold) the manager of DIA buys (or sells) shares in the underlying stocks that comprise the DJIA. In this way, new DIA shares are created (or destroyed) to meet the demand for DIA shares AND the overall price of DIA ETF moves to match the price changes of the DJIA.

     The price changes of DIA matches the price changes of the DJIA quite closely. Clicking on this sentence will show you a Yahoo Finance graph of the correspondence between DIA and the DJIA since the inception of DIA back in 1999. This is the correspondence with the DJIA that you can expect if you own shares of DIA. Note that dividends are NOT included in either graph.

Disclosure: The writer has no ownership in DIA, nor any intent to purchase it in the next 72 hours.

Introduction

     ETF stands for Exchange Traded Fund. Investing in and ETF is an simple and cheap way to invest in "the market". There are, however, hundreds of ETFs. Choosing requires matching your investment goals with the right ETF or ETFs.