Exchange Traded Fund (ETF)

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An exchange traded fund bears some similarity to a mutual fund based on an index ( index fund). Both are funds composed of a large number of different securities that have a common characteristic, so that an investor with limited resources is spared the anxiety of having to select a few individual securities in which to invest and hope that his picks prove successful. By investing in either an index-linked mutual fund or an ETF, the investor can gain the benefits (or suffer the losses) of the particular index or sector in which he wants to invest. But beyond that similarity, the two investment vehicles are different. An investor in the indexed mutual fund buys into the fund and receives for his money shares in the fund. Having bought the shares, the investor has only the choice between staying in the fund or leaving it. If he leaves he cashes in, or redeems, his shares with the fund and gets back the current value of the shares, which in turn is based on the current value of all the securities in the mutual fund's portfolio. An investor in an ETF, on the other hand, can actually sell his stake in the ETF on the open stock market; if the underlying securities in the ETF are doing well, the value of the ETF shares may be higher. This ability to trade ETF shares in the market rather than simply being able to redeem them is how exchange traded funds get their name: they are funds that can be traded on a stock exchange. ETFs are traded on the American Stock Exchange, the NASDAQ Stock Market, and the New York Stock Exchange. As the use of ETFs has evolved, a variation of the original ETF format received regulatory approval in 2008. Known as "active" ETFs, these ETFs allow fund money managers to change the securities that make up their funds almost whenever they wish, making the funds much less of a passive investment vehicle. In addition to the original ETFs, which were generally comprised of stocks, ETFs can invest in other assets such as bonds or commodities.