An ETF, or exchange traded fund, is a type of investment fund that trades on an exchange like a stock. It's like a basket that contains many other securities, like stocks, bonds, or commodities to name a few. But who decides which securities go into the basket, and how much of each? This duty falls to the fund manager, and they use the fund's investment goals to drive those decisions. Each ETF has a document called a prospectus. This document outlines the investment objectives strategies, fees and more. It will have an investment goal to help investors decide if it's a good fit for them. In many cases, the fund's goal will be to follow, or track, an index. An index is a hypothetical portfolio of securities created to measure the value of a specific market or segment of it. This type of ETF is classified as an Index Fund and we'll discuss them further in another lesson. However, there are ETFs that do not track an index but still have a stated goal. An example can be a fund that seeks to earn a high level of income by investing primarily in preferred shares and other income-producing securities. For the rest of this lesson, we'll focus on non-index ETFs. Since these don't have a defined list of components to follow for investment decisions, it is solely up to the fund manager to decide what the fund will invest in. So, in this case, if we think of the fund manager as a baker, they are told to make something specific, like chocolate chip cookies. However, they get to decide which ingredients to use and how much. This means that the fund's success depends on the decisions of the fund manager. Once the fund manager has invested the money, the fund then creates shares that represent a fraction of all the items in the fund. An investor will own these shares instead of having ownership in the individual securities that make up the fund. The shares are quoted and traded on an exchange just like normal stock shares. This means that you can buy or sell shares of an ETF whenever the exchange it trades on is open. The true value of a share of the ETF is called the NAVPS or Net Asset Value Per Share. The NAVPS is calculated by taking the net value of all the securities in the fund minus any liabilities, like operating or management expenses. We then divide that value by the number of shares created. Because ETFs trade on an exchange, share prices can move up or down with each trade due to supply and demand. This can cause shares to trade above the NAVPS, also known as trading at a premium. Or the shares can trade below the NAVPS, which is known as trading at a discount. Shares of the ETF are created or redeemed by approved financial institutions called authorized participants. This process prevents the share price from trading too far from the NAVPS. Of course, all the activities we have discussed so far, and others that we haven't, cost money, so where does this money come from? On an annual basis, all the costs associated with the operation of a fund are grouped together and then expressed as a percentage of the total value of the fund. The outcome of this formula is called the MER, or Management Expense Ratio. The MER is not paid directly out of your pocket, but it is paid out of the fund's assets. This decreases the NAV of the fund which impacts the value of each share you own. Depending on your broker, a fee you may pay directly out of your pocket are commissions…And a commission may be charged each time you buy or sell shares of an ETF. So be wary of the costs involved if you are placing many trades for small dollar amounts. Some ETFs pay distributions to shareholders. A distribution is kind of like a divided that a stockholder may receive. An ETF distribution is made up of all the dividends, interest, and capital gains that the fund's investments generated for a given period. Many ETFs are eligible for a Distribution Re-investment Plan…or DRIP…with brokers. By enrolling in a DRIP, you may be able to automatically re-invest or use your distributions to buy more shares of the ETF at no cost. To learn more about DRIP with TD Direct Investing, contact an Investment Representative. Investing in ETFs can help minimize the amount of research and trades an investor needs to perform. But how do you choose which ETF to buy among the hundreds that are out there? Watch our lesson on Researching an ETF on WebBroker to learn more.