ETFs (Exchange-Traded Funds) are investments that track a group of securities like stocks, bonds, or other commodities. One of the most common types of ETFs is a stock ETF, which tracks a group of stocks. But do ETFs actually hold stocks?
ETFs as a whole do actually hold stocks, but you do not own the stocks when you own shares of an ETF. The management company will buy the stocks when they create the ETF. The stocks and shares within the ETF are then split into shares which investors can buy without actually owning the stock.
This article will clearly explain:
- What stock ETFs are.
- How ETFs hold stocks.
- Why the ETF shareholders do not hold stocks.
Furthermore, in this article, we also compare stocks and ETFs since they have some significant similarities and differences. Finally, there are some recommended resources that you can use to learn more about ETFs and stocks, so let’s get started.
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Table of Contents
What Are Stock ETFs?
ETFs, or exchange-traded funds, are a type of fund that holds a group of securities and tracks their performance. The securities within an ETF can vary, but common ones are stocks, bonds, or commodities. The number of securities within an ETF can also vary from two to hundreds.
Investors can buy and sell shares of an ETF on the market. The share price changes as trades occur and are based on the prices of the securities within the ETF.
One of the most common types of ETFs is Stock ETFs, which track a particular set of stocks, usually those within a particular sector or industry. For example, some ETFs are made up of all technology stocks.
There are also stock ETFs that track stock indexes like the S&P 500 or the Nasdaq.
The price of one share of the ETF is usually slightly different but very similar to the total price of the shares of stock within the ETF.
For example, say an ETF holds three stocks:
- One stock trading at $5.
- One trading at $10.
- One is trading at $20.
The total price per share of the stocks is $35, so the price per share of the ETF will likely be trading around $35, give or take a few cents or dollars.
If the price per share of the ETF is trading at less than the total price of the stocks, then you are buying the ETF at a good price. As for selling the ETF, the opposite is true.
The Way an ETF Holds Stocks
When you own a share of an ETF, you do not own shares of the stocks or other securities within the ETF. You only own a share of the ETF.
When ETFs are created, the manager has to make a plan for their ETF and get it approved. Then a second party, usually an authorized participant, will purchase the shares of the stocks and any other securities in the ETF.
After the securities are purchased, shares of the ETF are put onto the market to be bought and sold by investors. When the investors purchase shares of the ETF, they are not buying shares of the securities within the ETF, just shares of the ETF itself.
The ETF manager is the one who holds the stock so that they are not constantly dividing and managing who owns the shares within the ETF as they are bought and sold.
If investors purchased shares of the stocks within the ETF, it would be similar to having a stockbroker manage a stock portfolio for you. They would choose the stocks for you, and you would buy the shares of the stock.
If they were to be doing the job of a stockbroker, the fees that the investors pay would be much higher.
How Are ETFs and Stocks Similar?
The primary way that ETFs and stocks are similar is that they both trade on an exchange. When their respective markets are open, investors can buy and sell shares of stocks and ETFs. The price per share changes depending on the capacity of trades.
Outside factors like company announcements and political events can also affect share prices.
Another way that ETFs and stocks are similar is that they are both investments that carry risk. There is no guarantee that the money you invest in stocks or ETFs will return a profit, and you may lose money on the investments if the market crashes or the stocks you invest in lose value.
You will have to pay taxes on the returns from both stocks and ETFs. The tax will depend on how much money you made on top of your purchase price.
You might also need to pay fees to the brokerage that manages your trades or your fund.
The Way That ETFs and Stocks Are Different
Since ETFs are made up of multiple securities, they are more diversified than a single stock. Diversified investments are typically better, because if one stock within your ETF loses value, the price may decrease, but the others will keep the price from drastically decreasing.
On the other hand, if you own a share of a single stock and the price goes down, you can be facing a big, instant loss with nothing to offset it.
Furthermore, stocks are a more liquid investment than ETFs. In general, shares of stocks trade more often than ETFs, so it is easier to sell them when you are ready to do so. Contrarily, ETFs can be harder to sell, especially if you are investing in a less common fund.
Learn About ETFs and Stocks
If you want to invest in stock ETFs or just stocks in general, you need to first understand how they work and then choose the best ones to invest in based on your individual investment goals. This section has some books and videos that you can use to learn more about both.
Video Resources
This video from Learn to Invest on YouTube compares stocks and ETFs so you can understand the difference between them and decide which one is best for you:
Next, this video on YouTube from New Money explains five things that beginners should know before investing in an ETF, especially if you have not invested before:
Book Resources
A great book to get started with is Guide to investing in Stocks, Bonds, ETFs, and Mutual Funds: A Beginner’s Guide to Building Wealth from Amazon.com. You will learn about stocks, ETFs, and a variety of other investments in this easy-to-understand book.
Another helpful book is ETF Investing: The Beginners Guide to Create Passive Income and Achieve Financial Freedom with ETF (Stock Market Investing) from Amazon.com.
As ETFs grow in popularity, more investors are flocking towards them. But, before making any sizable investment in these instruments, make sure you understand how they work, how they change in price, how to analyze them, and how to find the best ones for you to invest in based on your individual investment goals.
Author’s Recommendations: Top Trading and Investment Resources To Consider
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Conclusion
ETF managers hold the stock that is in their ETFs. However, the shareholders of the ETF do not own the actual stock. ETFs, in essence, are just tracking a group of stocks, so their share price is based on the stocks held within them.
However, when you sell your share of the ETF, you are not affecting the stock prices at all, as it is separate.
If you want to diversify your portfolio, looking into an ETF might be the way to go. But it is important to note that while diversification reduces your risk for heavy losses, it does not completely shield you from it. So, make sure you fully understand the risks associated with an investment, before going big on it!
BEFORE YOU GO: Don’t forget to check out my latest article – ‘Exploring Social Trading: Community, Profit, and Collaboration’. I surveyed 1500+ traders to identify the impact social trading can have on your trading performance, and shared all my findings in this article. No matter where you are in your trading journey today, I am confident that you will find this article helpful!
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