From a Rejected 1989 Idea to the Way Millions of Americans Invest

Exchange-traded funds began as an idea almost nobody wanted. Today they hold trillions of dollars of Americans’ savings, sit inside millions of 401(k)s, IRAs and brokerage accounts, and have become the default way many people invest for the long term.

If you are trying to understand ETFs, whether you are making your first investment or reviewing what you already own, this guide is the place to start. It explains where ETFs came from, how they work, how they are regulated, the different types available, what they cost and how they are taxed.

It also connects you to every guide in FRC’s ETF and Retail Investing series, so you can go deeper on any topic, from choosing a brokerage account to understanding JEPI, gold ETFs or the order in which to use your 401(k) and IRA. FRC has no stake in what you buy: we do not sell investments, manage portfolios or earn commission, so everything here is explained impartially.

Prefer to watch? The full FRC Retail Investing video series is on YouTube, with short, fact-checked explainers on the ETFs and accounts American investors use most.

What an ETF Is

An exchange-traded fund, or ETF, is a fund that holds a basket of investments, such as stocks, bonds or commodities, and trades on a stock exchange like a single share. Buying one share of an ETF gives you a small slice of everything the fund holds.

Most ETFs track an index, such as the S&P 500, and aim to match its performance rather than beat it. Others are actively managed, with portfolio managers choosing the holdings, and some use options or other strategies to generate income or change their risk.

Because ETFs trade throughout the day, their prices move continuously while the market is open. That sets them apart from traditional mutual funds, which are priced only once a day after the market closes.

If you are completely new to investing, FRC’s ETF Investing for Beginners course explains the fundamentals step by step. ETF Investing Strategies then shows how to build ETFs into a complete portfolio, and Advanced ETF Investing covers specialised structures in depth.

The Idea Nobody Wanted

The story of the ETF begins after the stock market crash of October 1987. In its aftermath, regulators and exchanges looked for ways to let investors trade an entire market basket in a single transaction.

In 1989, the American Stock Exchange and the Philadelphia Stock Exchange launched Index Participation Shares, an early attempt at a tradable basket. The Chicago Mercantile Exchange and others challenged them in court, arguing they were really futures contracts, and a federal court agreed, forcing them off the market.

Canada moved first with a lasting product. In March 1990, the Toronto Stock Exchange launched Toronto 35 Index Participation units, known as TIPs, which many historians regard as the first successful modern ETF.

Nathan Most, Kathleen Moriarty and the First SPDR

In the United States, the breakthrough came from the American Stock Exchange. Nathan Most, an executive there with a background in commodities, and his colleague Steven Bloom designed a fund structure that could trade like a share while holding a basket of stocks.

Turning the idea into a legal product took years. Attorney Kathleen Moriarty led the work of fitting the new structure within US securities law, and the SEC review process took several years.

On January 22, 1993, the SPDR S&P 500 ETF Trust, ticker SPY, began trading. It remains one of the largest and most heavily traded ETFs in the world, and its launch is generally seen as the start of the modern US ETF industry.

How the ETF Market Grew

After SPY, new ETFs followed steadily. A mid-cap fund arrived in 1995, international country funds in 1996, and the Select Sector SPDRs, which split the S&P 500 into sectors, in 1998.

In 1999, the fund now known as the Invesco QQQ Trust launched to track the Nasdaq-100. Bond ETFs followed in 2002, and in 2004 SPDR Gold Shares, GLD, became the first major US ETF backed by physical gold.

Leveraged and inverse ETFs arrived in 2006, Vanguard expanded into ETFs in the early 2000s, and in 2009 BlackRock acquired Barclays Global Investors, including its iShares business, creating the world’s largest ETF provider. In January 2024, the SEC approved the first spot bitcoin exchange-traded products.

How ETFs Have Held Up Under Stress

ETFs have been tested by several market crises. During the 2008 financial crisis and again in March 2020, trading volumes in ETFs surged as investors rushed to adjust their portfolios, and the largest funds continued to trade throughout.

Stress also revealed limits. In March 2020, some bond ETFs traded at noticeable discounts to the reported value of their holdings, because the underlying bonds were trading far less often than the ETF shares themselves.

Regulators and researchers have studied these episodes closely. They show that an ETF’s trading is only as smooth as the market for what it holds, something to keep in mind for funds that invest in less frequently traded assets.

The Providers Behind the Funds

Three firms manage a large share of US ETF assets. BlackRock runs the iShares range, Vanguard is known for very low-cost index funds, and State Street manages the SPDR family, including SPY.

Other major providers include Charles Schwab, Invesco, Fidelity and J.P. Morgan Asset Management, whose income funds have become some of the most widely held ETFs in the country. FRC’s dictionary entry on JPMorgan explains the firm’s role in US markets.

Each provider publishes a fund page, fact sheet and prospectus for every ETF it manages. Those official documents are always the source to rely on for current fees, holdings and risks.

ETFs Compared With Mutual Funds and Index Funds

ETFs, mutual funds and index funds are often confused, because the terms overlap. A mutual fund is a pooled investment priced once a day, an ETF is a pooled investment that trades on an exchange throughout the day, and an index fund is any fund, ETF or mutual fund, that tracks an index.

Many index funds exist in both forms. Vanguard’s S&P 500 fund, for example, is available as the ETF VOO and as a mutual fund share class, holding the same underlying portfolio.

The practical differences come down to how you buy them, the minimum investment, when trades are priced and how tax-efficient the structure is in a taxable account. For long-term investors in a retirement account, the choice between an ETF and an equivalent index mutual fund often makes little difference to the result.

How ETFs Work Behind the Scenes

ETFs have two markets. In the secondary market, ordinary investors buy and sell ETF shares with each other on an exchange, just like shares of a company.

In the primary market, large financial firms called authorised participants create and redeem ETF shares directly with the fund. When demand rises, they deliver a basket of the underlying securities to the fund in exchange for new ETF shares, and when demand falls, they do the reverse.

This creation and redemption process helps keep an ETF’s share price close to the value of its holdings, known as its net asset value. If the price drifts too far from that value, authorised participants have a financial incentive to step in and close the gap.

The Mechanics Most Investors Never See

Several less visible features shape how ETFs behave. One is tracking error, the gap between a fund’s return and the return of the index it follows, which comes from fees, trading costs and the way the fund holds its securities.

Another is the way ETFs manage tax. Because ETFs usually exchange securities with authorised participants rather than selling them for cash, they can often remove holdings with built-in gains without triggering a taxable sale inside the fund, which is one reason many broad ETFs pay few or no capital gains distributions.

A third is index reconstitution. When an index adds or removes companies, funds tracking it must trade, and those predictable trades can create small costs that are rarely visible to investors. FRC’s guide to how ETFs are regulated and traded explains these mechanics in depth.

How ETFs Are Regulated

Most US ETFs are registered with the SEC under the Investment Company Act of 1940, which sets rules on diversification, governance, conflicts of interest and disclosure. In 2019, the SEC adopted SEC Rule 6c-11, which standardised the framework for most ETFs and allowed many to launch without individual exemptions.

Some exchange-traded products are structured differently. Physically backed gold ETFs and spot bitcoin ETFs are trusts that register their shares under the Securities Act of 1933 and are not covered by the 1940 Act’s full protections.

Brokerage firms that sell ETFs are regulated by FINRA, which oversees how they deal with customers. Under FINRA Rule 2111, a firm recommending an investment must have a reasonable basis to believe it is suitable, and FINRA has warned that leveraged and inverse ETFs are typically unsuitable for retail investors who hold them for more than a day.

The Main Types of ETF

The most common ETFs track broad stock market indexes. S&P 500 funds such as VOO, IVV and SPY hold around 500 of the largest US companies, while total market funds such as VTI hold thousands, and Nasdaq-100 funds such as QQQ concentrate on large growth and technology companies.

FRC’s comparison of VOO, VTI and QQQ explains how the three most popular stock ETFs overlap and differ. Fidelity investors often use mutual fund equivalents, which FRC’s guide to Fidelity index funds compares in detail.

Bond ETFs hold government, corporate or municipal debt and are often used for stability and income. Beyond stocks and bonds, there are sector funds, international funds, commodity funds and specialised strategies, which FRC’s guide to ETF types, costs and investment strategy sets out in full.

Income ETFs

Many investors use ETFs to generate regular income. Dividend ETFs pass on dividends from the companies they own, and FRC’s guide to SCHD for passive income explains one of the most popular.

Covered call ETFs add income by selling options, giving up part of their upside in exchange. FRC’s guides to covered call ETFs and to JEPI, the JPMorgan Equity Premium Income ETF explain how these funds work and how their income is taxed.

The central lesson across all income ETFs is that a high yield is not the same as a high total return. Income, price changes, tax and risk all need to be considered together.

Specialised ETFs: Gold, Bitcoin and Leverage

Some ETFs give access to assets that were once hard for ordinary investors to own. Gold ETFs hold physical gold bars in vaults, and FRC’s guide to gold ETFs explains how GLD and IAU compare, including the collectibles tax rule on long-term gains.

Spot bitcoin ETFs hold actual bitcoin, kept by a professional custodian. FRC’s guide to bitcoin ETFs explains how IBIT and FBTC work, what you do and do not own, and what the SEC said when it approved them.

Leveraged ETFs aim to multiply the daily return of an index, which can cause them to lose value over time even when the index rises. FRC’s guide to leveraged ETFs explains why TQQQ and SOXL behave so differently from ordinary funds.

How to Read an ETF Fact Sheet

Every ETF publishes a fact sheet, usually a two-page summary on the provider’s website. Learning to read one takes only a few minutes and answers most of the questions investors have about a fund.

The key items are the fund’s objective and index, its expense ratio, its total assets and trading volume, its top holdings and sector weights, its number of holdings and its distribution yield and frequency. Performance tables show returns over different periods, alongside the index the fund tracks.

The fact sheet is a summary, not the full picture. The prospectus explains the fund’s strategy, risks and costs in detail, and it is the document regulators require funds to provide to investors.

What ETFs Cost

Every ETF charges an annual fee called the expense ratio, taken automatically from the fund’s assets. Broad index ETFs charge some of the lowest fees available, often a few hundredths of one percent a year, while specialised and actively managed funds usually charge more.

Small differences in fees compound over time. As an illustration, a 1 percent difference in annual costs could reduce the value of $500 a month invested over 30 years at 7 percent from roughly $610,000 to roughly $502,000.

Most large US brokers now charge no commission on online ETF trades, but investors still pay the bid-ask spread each time they buy or sell. Checking each fund’s expense ratio before buying is one of the simplest ways to keep more of your returns.

How ETFs Are Taxed

In a taxable brokerage account, ETF dividends are taxed in the year you receive them, and gains are taxed when you sell. Qualified dividends and long-term gains are taxed at lower rates than ordinary income, provided you meet the holding period rules.

Broad stock ETFs are often more tax-efficient than comparable mutual funds, because of the way they exchange securities with authorised participants. But some ETFs, such as covered call funds, bond funds and gold trusts, can create more tax, or tax at different rates.

FRC’s guide on how to choose tax-efficient ETFs for a taxable brokerage account explains which fund structures tend to produce less tax, and how to decide what belongs in each account.

Choosing Where to Hold Your ETFs

Before buying an ETF, you need an account to hold it. FRC’s guides on what a brokerage account is, how to choose a brokerage account and the brokerage accounts most popular with beginners walk through the options.

Many investors also want to know whether a particular firm is safe. FRC has published guides on whether Fidelity, Charles Schwab, Vanguard and Robinhood are safe, along with a head-to-head comparison of Fidelity vs Charles Schwab vs Vanguard.

The account type counts as much as the firm. FRC’s guide to the order to invest your money between a 401(k), IRA and brokerage account explains how employer matches, Roth and traditional IRAs and taxable accounts fit together, with the 2026 contribution limits.

How Your Money Is Protected

ETF shares held at a US brokerage firm are securities held in your name, separate from the firm’s own money under SEC customer protection rules. If a member firm fails, SIPC can help return customers’ securities, up to its limits.

No protection scheme covers a fall in the value of your investments. FRC’s guides on whether your money is safe in a brokerage account and what happens if your brokerage goes bankrupt explain exactly what is and is not protected.

Protection also depends on dealing with a properly registered firm. FRC’s guide on how to use FINRA BrokerCheck shows how to check any firm or financial professional in a few minutes.

Avoiding Unregulated Firms and Scams

The popularity of ETFs has also attracted fraud. Fake trading apps, imposter websites and social media promoters offering guaranteed returns all target investors who are new to the market.

FRC’s guide on how to avoid investment scams explains the warning signs. Its guides to unregulated brokers and to what happens if you invest with an unlicensed broker explain why the protections described above may not apply outside the regulated system.

A real ETF trades on a US exchange under a ticker you can look up, and its prospectus is filed with the SEC. If an offer cannot be checked in those places, treat it as a warning sign.

Building Wealth With ETFs

ETFs are most powerful when combined with time, low costs and consistency. FRC’s guide on how compound interest builds wealth in ETFs shows why starting early can make such a large difference.

Many investors build wealth by investing a fixed amount every month. FRC’s guide to dollar-cost averaging vs lump sum investing explains how regular investing works, and its guide to what $500 a month in an S&P 500 ETF could grow to over 30 years shows the maths, clearly labelled as illustrations.

For investors starting with a lump sum, FRC’s guide on how to invest $10,000 in ETFs explains how many Americans approach the account, the funds and the timing.

Your Step-by-Step Route Through ETF Investing

With so many guides available, it helps to follow them in order. Start with the foundations: what an ETF is, what a brokerage account is, and how to choose a regulated firm and check it on BrokerCheck.

Next, decide where your money goes, using the 401(k), IRA and brokerage order, and then choose your core funds, such as a broad S&P 500 or total market ETF. After that, explore income, tax efficiency and specialised funds as your knowledge grows.

FRC’s complete step-by-step guide to investing in ETFs brings that route together in one place, linking each step to the guide that covers it.

How Many ETFs Do You Need?

With thousands of ETFs available, new investors often assume more funds mean more diversification. In practice, a single broad index ETF already holds hundreds or thousands of companies.

Many long-term investors build a simple portfolio from two or three broad funds, such as a total US stock fund, an international stock fund and a bond fund. Adding several US stock funds that hold the same large companies can increase overlap rather than reduce risk.

The right number depends on your goals, but simplicity has real advantages. A portfolio you understand, can explain and can stick with during a market fall is usually more valuable than a complicated one.

The Risks Every ETF Investor Should Understand

An ETF is only as safe as what it holds. A broad stock ETF can fall sharply in a market downturn, a bond ETF can lose value when interest rates rise, and a specialised fund can be far more volatile than the market as a whole.

Diversification reduces the risk of any single company failing, but it does not remove market risk. In 2008, the S&P 500 fell by more than a third in a single year, and diversified stock ETFs fell with it.

The most common mistakes are behavioural: buying whatever has risen most recently, selling in a panic during a fall, and choosing complex products without understanding them. Learning how ETFs work is the most effective protection against all three.

For Those Working in the Industry

ETFs are also a core topic for anyone building a career in financial services. Questions on investment companies, ETF structure, trading and suitability appear on the Securities Industry Essentials exam and the Series 7.

FRC’s SIE Exam Preparation and Series 7 Exam Preparation courses cover these products in the context of the rules professionals must follow.

Understanding ETFs from both sides, as an investor and as a regulated professional, is exactly the perspective FRC’s courses and dictionary are built to provide.

Common Questions

What is an ETF in simple terms? An ETF is a fund that holds a basket of investments and trades on a stock exchange like a single share. Buying one share gives you a small slice of everything the fund holds.

What was the first ETF? Canada’s Toronto 35 Index Participation units, launched in 1990, are widely regarded as the first successful modern ETF. In the United States, SPY, the SPDR S&P 500 ETF Trust, began trading on January 22, 1993.

Are ETFs safe? ETFs held at a regulated US broker are protected against the broker’s failure, up to SIPC’s limits, but not against a fall in value. How risky an ETF is depends entirely on what it holds.

What is the difference between an ETF and a mutual fund? Both pool investors’ money into a portfolio. ETFs trade throughout the day on an exchange, while mutual funds are priced once a day, and ETFs are often more tax-efficient in a taxable account.

How do I start investing in ETFs? Many investors start by opening an account at a regulated broker, deciding which account type to use, and choosing a broad, low-cost index ETF as a core holding. FRC’s step-by-step guide walks through each stage.

Learning How ETFs Work Is Open to Everyone

You do not need a finance background to understand ETFs. Their history, mechanics, regulation, costs and tax treatment can all be learned, and understanding them is what turns a popular investment into a confident long-term plan.

FRC’s programmes and memberships are open to everyone. Start with ETF Investing for Beginners if you are new, move on to ETF Investing Strategies to build a complete portfolio, and continue to Advanced ETF Investing when you are ready to go deeper.

FRC’s Professional Membership adds structured learning, verified progress and a growing set of tools for investors who want to keep building their knowledge. The FRC dictionary, with explainer videos on the rules behind US investing, is free for everyone.

Your Next Step

ETFs began as an idea that regulators, exchanges and courts struggled to accept. Three decades later, they are one of the simplest, lowest-cost and most widely used ways for ordinary Americans to invest.

Choose the guide that matches where you are today, whether that is opening your first account, choosing a fund or understanding tax. Then carry on with FRC’s complete step-by-step guide to investing in ETFs, and build your knowledge one step at a time.