An exchange traded fund or ETF is an investment that contains the same stocks of a stock market index, in the same proportion as the stock index. If you are thinking this sounds a lot like index funds, you would be correct!
How ETFs are priced
The price of an ETF is determined by the value of the stocks contained in the ETF. For example Vanguard VTI is an ETF that covers most of the stocks available in the US. As the price of the underlying stocks change value, the ETF price will also change because investors will bid the ETF shares higher or lower. Keep in mind that ETFs can hold investment that are not stocks as well, such as bonds.
Differences between ETFs and index funds
One of the key differences between index funds and ETFs is that index funds are priced once a day. It doesn’t matter what time you put your order in, the price you get will be set at the end of the trading day. ETFs on the other hand are priced throughout the day in a similar fashion to stocks. Every time some shares of an ETF are bought and sold, the price might be adjusted.
Another way that ETFs are different from index funds is the costs. In theory, ETFs have a cheaper management fee than index funds but since you have to buy and sell them like stocks, there will be a trading fee every time you buy or sell an ETF. Usually with index funds, there are no fees for purchasing or selling them. Both ETFs and index funds are generally much cheaper than a managed mutual fund.