ETF (Exchange Traded Fund)

ETFs (exchange-traded funds) are a bunch of stocks in one investment that are linked to an index (like the Dow or the S&P 500).

When an ETF is set up, someone buys up stocks in the companies listed in a specific index in the same amount as the index itself. Your ETF is based on the FUN* index that's made up of stocks in ten candy and video game companies? Great, your ETF will have stocks in those ten companies. Here's where things get interesting: the thing about an ETF is that no changes are made to the fund as the index changes. Over time, some companies might fold or might be replaced on the index. Some companies might tank. No matter. Your ETF will remain pretty much true to the index on the day your fund was created—no big changes. 

By the way, ETFs may look like mutual funds (they are a collection of stocks, after all) but they trade like stocks on the markets. 

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 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? It depends on the original documentation of the fund and the fund manager's job is to rebalance" over time.

ETFs do pretty much the opposite. No uber bean-counter, no rebalancing. Like your uncle Dennis's comb-over, the style stays the same.

*not a real index; sorry, dudes