What Are ETFs and How Do They Work?

ETF stands for "Exchange Traded Fund", a type of investment fund traded on the stock exchange. While ETFs are often discussed separately from traditional funds, they are technically a subcategory of them. Confusion can arise because in everyday language, "funds" usually refers to actively managed ones, whereas ETFs are generally passive.

The key difference is that ETFs are traded on the stock exchange. ETFs typically aim to replicate the performance of a specific index — such as the German DAX — as closely as possible, and they are mostly passively managed.

How an ETF Works: Example

An ETF based on the MSCI World Index invests in around 1,400 companies globally (as of 02/2025). The ETF acts like a basket containing all the shares from the index. When investors buy shares in the ETF, they are effectively buying a portion of that basket and benefit from the performance of the included stocks. To mirror the index, the ETF typically includes the exact same securities. ETFs allow investors to cost-effectively access entire markets with a single investment, offering a chance to build long-term wealth.

Besides stocks, ETFs can also provide exposure to other asset classes such as bonds, commodities, and real estate. There are many different types of ETFs available:

How Do ETFs Differ from Actively Managed Investment Funds?

Unlike passive ETFs, actively managed funds have a fund management team that selects, buys, and sells securities individually to maximize returns. Ideally, this active management aims to outperform the market.

However, an actively managed fund can also underperform compared to a comparable ETF. Performance depends on the decisions made by fund managers and the prevailing market conditions. Since passive ETFs replicate an existing index automatically, there is no need for a fund manager to select and manage assets.

ETFs also differ from traditional funds in how they are traded. ETFs are bought and sold on stock exchanges, while mutual funds are transacted through fund providers. ETF shares can be traded at market prices during exchange trading hours, whereas mutual fund shares can only be redeemed through the fund company, typically at a price determined once per day.

In addition to trading mechanisms, another major difference between passive ETFs and actively managed funds lies in fund management and cost. ETFs are significantly more cost-efficient due to lower total expense ratios compared to actively managed funds.

Are Index Funds the Same as ETFs?

Alongside the terms "ETF" and "fund", the term "index fund" is also frequently used. Index funds are investment funds that track the performance of a market index. These characteristics are typically associated with ETFs. In reality, an index fund can be an ETF, but not all ETFs are index funds, even though the terms are often used interchangeably.

Index funds follow a passive investment strategy that mirrors an index. Passive ETFs also replicate index performance and are therefore considered index funds. However, there are also active ETFs that are managed independently and are not tied to a specific index. Additionally, there are passive mutual funds — issued by fund providers — that track an index and are considered index funds as well. So, the term "index fund" simply means the fund follows a passive strategy, regardless of asset class or whether it’s traded on an exchange or through a fund company.

How Do ETFs Differ from Actively Managed Investment Funds?

Unlike passive ETFs, actively managed funds rely on a fund manager to select, buy, and sell securities in an effort to outperform the market. However, they can also underperform depending on market conditions and management decisions. ETFs, on the other hand, passively track an index, eliminating the need for active selection.

ETFs also differ in how they are traded. They are bought and sold on stock exchanges throughout the day at market prices. Traditional funds, by contrast, are transacted through fund companies at a fixed price set once per day.

Are Index Funds the Same as ETFs?

The term "index fund" refers to a fund that passively tracks a specific index. While all passive ETFs are index funds, not all index funds are ETFs. These terms are often confused or used interchangeably, but important distinctions remain.

In summary, while ETFs and index funds share characteristics, they are not always identical. The key differences lie in management style and how they are traded.

Opportunities and Risks of ETFs

ETFs offer an attractive way to invest in the capital market with lower risk than individual stocks, making them potentially suitable for beginners. However, like any investment, they come with certain risks.

Opportunities of ETFs

Risks of ETFs

Which ETF Is the Best?

The best or most suitable ETF is a personal decision. Investors have different preferences and levels of risk tolerance. For example, they can choose between distributing and accumulating ETFs — meaning returns are either paid out or reinvested. Additionally, ETFs can focus on specific markets, such as sustainable investments or the Asian market.

To achieve broad diversification, it can be beneficial to invest in multiple ETFs. This allows coverage of various markets and helps reduce sector and country-specific risks. With WeltSparen’s digital wealth management, investors gain global exposure through ETF portfolios that consider regional economic strength for a well-balanced investment.

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Risk Notice: Every capital market investment involves opportunities and risks. The value of investments can rise or fall. In the worst case, a total loss of the invested amount is possible. You can find all detailed information under Risk Notices.