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What is an ETF? The ABCs of exchange-traded funds

Previously in the series: ETF investing - from zero to hero; Discover why ETFs are transforming how people build wealth.

Exchange-traded funds (ETFs) have transformed the investment landscape, making it easier than ever for everyday investors to build diversified portfolios. But what exactly are these investment vehicles that have attracted trillions of dollars worldwide?

The building blocks of ETFs

At its core, an ETF is a collection of securities—stocks, bonds, commodities, or other assets—bundled together and traded on exchanges just like individual stocks. Think of an ETF as a shopping basket filled with dozens or hundreds of different investments that you can buy or sell with a single transaction.

When you purchase an ETF share, you're not buying direct ownership in the underlying companies. Instead, you're buying a portion of a fund that owns those assets on your behalf. This structure creates several distinct advantages for investors.

How ETFs work in practice

Unlike mutual funds, which only trade once daily after markets close, ETFs trade continuously throughout the day. This means you always know the exact price you'll pay or receive when you place an order.

For example, if you purchase a share of an S&P 500 ETF, you instantly gain exposure to all 500 companies in that index—from tech giants like Apple and Microsoft to consumer brands like Coca-Cola and Procter & Gamble—with a single transaction that costs as little as the price of one ETF share.

The three pillars of ETF benefits

1. Diversification made simple

ETFs instantly spread your investment across multiple securities, reducing the impact of any single company's poor performance. A Saxo Bank client with just €1,000 can access a portfolio that might contain hundreds of global companies across various industries.

2. Liquidity when you need it

Unlike some investments that lock up your money, ETFs can be bought or sold whenever markets are open. This liquidity gives you flexibility to adjust your portfolio or access your funds when needed.

3. Cost efficiency that preserves returns

ETFs typically charge lower fees than actively managed funds. While a difference of 0.5% or 1% might seem small, these savings compound dramatically over time, potentially adding thousands to your investment returns.

Passive vs. active ETFs: understanding the difference

Most ETFs are passive investments, meaning they simply track an existing index like the S&P 500 or MSCI World. The fund manager's job is to mirror the index's performance as closely as possible, not to try outperforming it. This passive approach keeps costs low and provides predictable exposure to the chosen market segment.

Active ETFs, while less common, employ portfolio managers who make decisions about which securities to buy and sell. These funds aim to outperform their benchmarks but typically charge higher fees to cover the cost of active management.

For Saxo Bank clients looking to build long-term wealth, ETFs offer a powerful combination of simplicity, diversification, and cost efficiency. Whether you're taking your first steps into investing or refining an established portfolio, understanding these investment building blocks is essential to making informed financial decisions.

Next up: We’ll explore the different types of ETFs—from equity and bond ETFs to thematic and ESG-focused funds—and how to choose the ones that match your investment goals.

Data sources: Investment Company Institute, BlackRock Global ETF Landscape Report