{"id":1004301,"date":"2023-01-10T18:37:09","date_gmt":"2023-01-10T23:37:09","guid":{"rendered":"https:\/\/www.finder.com\/ca\/?p=1004301"},"modified":"2026-03-09T18:25:52","modified_gmt":"2026-03-09T22:25:52","slug":"how-etfs-work","status":"publish","type":"post","link":"https:\/\/www.finder.com\/ca\/stock-trading\/how-etfs-work","title":{"rendered":"How do ETFs work?"},"content":{"rendered":"

ETFs are one of the easiest ways to invest in a diversified portfolio without having to pick individual stocks or bonds. They\u2019re popular with beginners for their simplicity and with experienced investors for their versatility. But exactly how do ETFs work and how can you use them to make money? Keep reading to find out.<\/p>

What is an ETF?<\/h3>

An exchange-traded fund, or ETF, is an investment fund that pools money from many investors to buy a diversified collection of assets, such as stocks, bonds, currencies or commodities.<\/p>

When you purchase a share of an ETF, you don\u2019t directly own the underlying assets or companies. Instead, you own a share of the fund, which gives you instant exposure to multiple investments through a single trade.<\/p>

Unlike mutual funds, ETFs trade on stock exchanges, allowing investors to buy and sell shares at fluctuating market prices whenever the exchange is open. ETFs also charge a management expense ratio (MER), which is deducted automatically from the fund.<\/p>

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\nRelated: <\/span>Guide to 10 of the best ETFs in Canada<\/a>\n<\/div>\n<\/article>

How do ETFs work?<\/h3>

ETFs are created and managed by fund providers that assemble a basket of assets designed to track a specific index, sector or investment theme like sustainability. Large financial institutions, known as authorized participants, create or redeem ETF shares as needed to help keep the ETF\u2019s market price close to its net asset value (NAV).<\/p>

Most ETFs are passively managed and aim to replicate the performance of their underlying benchmark by holding the same securities in similar proportions, so if Amazon (AMZN)<\/a> represents 3% of the market index, it will also make up 3% of the ETF\u2019s holdings. However, some ETFs are actively managed, with portfolio managers selecting investments in an attempt to outperform the market.<\/p>

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\nRelated: <\/span>Guide to 10 of the best ETFs in Canada<\/a>\n<\/div>\n<\/article>

Key terms for ETFs<\/h3>
Term<\/th>Definition<\/th><\/tr><\/thead>
Number of holdings<\/td>This refers to how many individual securities (such as stocks or bonds) an ETF owns. An ETF with more holdings is typically more diversified.<\/td><\/tr>
Holding allocations<\/td>Holding allocations show how much of the ETF is invested in each security, usually expressed as a percentage of the total portfolio.<\/td><\/tr>
Management expense ratio (MER)<\/td>The MER is the annual fee charged by the ETF provider to manage the fund, expressed as a percentage of assets. It covers operating and management costs and is deducted automatically.<\/td><\/tr>
Trading volume<\/td>The number of shares or units of a security that are bought and sold over a specific period, often used to gauge market activity and liquidity.<\/td><\/tr>
Distribution frequency<\/td>This indicates how often the ETF pays out income to investors, such as monthly, quarterly or annually. Distributions can include dividends, interest or capital gains, depending on the ETF\u2019s holdings.<\/td><\/tr>
Distribution yield<\/td>The distribution yield represents the income an ETF pays out relative to its price, usually shown as a percentage. It\u2019s often based on recent distributions and can fluctuate over time, especially for income-focused ETFs.<\/td><\/tr>
Sectors<\/td>Sectors describe the industries or parts of the economy the ETF is exposed to, such as technology, healthcare or energy.<\/td><\/tr>
Underlying index<\/td>Many ETFs are designed to track a specific index, such as the S&P 500 or Nasdaq-100. The underlying index determines which securities the ETF holds and how they\u2019re weighted.<\/td><\/tr>
Net asset value (NAV)<\/td>NAV is the per-share value of the ETF\u2019s underlying assets. ETF prices usually trade close to their NAV, but can be slightly higher or lower during market hours.<\/td><\/tr>
Liquidity<\/td>Liquidity refers to how easily an ETF can be bought or sold without significantly affecting its price. It\u2019s often influenced by trading volume and the liquidity of the ETF\u2019s underlying holdings.<\/td><\/tr>
Tracking error<\/td>A tracking error is the difference between an ETF\u2019s performance and the performance of the index it\u2019s designed to track. It occurs due to factors like management fees, trading costs, cash holdings and currency effects.<\/td><\/tr><\/tbody><\/table>

Features of ETFs<\/h3>

ETF features include:<\/p>