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Finance Glossary

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ETF - Exchange Traded Fund


Index Funds vs. ETFs One key elemental thing worth understanding is the difference between index funds and exchange traded funds. Index funds are NAV beasts - that is, each day, an uber-bean-counter adds up the stocks and/or bonds in a fund and calculates its value. Periodically (monthly-ish), the fund manager rebalances the fund. Let's say that a company in the S&P 500 is acquired by another or (more poignant lately), goes bankrupt. Well, it has to be replaced in the index. Or let's say a stock has a monster run and gets huge - should Apple still be 16% of the QQQQ index? Is that reflective of a NASDAQ portfolio? (AAPL is currently about 5% of the NASDAQ composite). It depends on the original documentation of the fund and the fund manager's job is to rebalance" over time.

ETFs (exchange-traded funds) don't do this. They are a set basket of stocks, which just live on more or less indefinitely, drifting away from their original indices as various stocks perform differently from the market and weightings change - sometimes dramatically over time.