ETFs for the Long Run: What They Are, How They Work, and Simple Strategies for Successful Long-Term Investing

CHAPTER 3

The Evolution of the ETF

Like mutual funds, ETFs are investment companies. According to the Securities and Exchange Commission (SEC), an investment company is:

... a company (corporation, business trust, partnership, or limited liability company) that issues shares and is primarily engaged in the business of investing in securities. An investment company invests the money it receives from investors on a collective basis, and each investor shares in the profits and losses in proportion to the investor’s interest in the investment company. The performance of the investment company will be based on (but it won’t be identical to) the performance of the securities and other assets that the investment company owns.¹

 

Typically, investment companies are diversified portfolios comprised of a variety of assets. The appeal of the investment company is that it’s an easy way for an individual investor to own a highly diversified portfolio at a fraction of the cost of purchasing each individual stock outright. Considering that the cost of building a diversified portfolio may be prohibitive for an individual investor who doesn’t have much capital, the benefit of joining an investment company is immediate. A large group of investors pooling their money together creates much more buying power than any one individual could muster on his own.

An individual investor with $1,000 doesn’t have enough money to create a truly diversified portfolio. He might be able to buy one share of many ...