What Is an ETF and How Does It Work?

By Adam Patti, Chief Executive Officer, VistaShares | Published November 13, 2026

An exchange-traded fund, or ETF, is an investment fund whose shares trade on a stock exchange throughout the day, like shares of a company. Each ETF holds a portfolio of assets, such as stocks, bonds or options, and each share represents a portion of that portfolio. A process called creation and redemption allows large financial firms to add or remove shares, which helps keep an ETF’s market price close to the value of its holdings.

How big is the ETF market?

ETFs have become one of the most widely used investment vehicles. Assets in U.S.-listed ETFs reached about $16.24 trillion at the end of September 2026, according to ETFGI, after the industry recorded 53 consecutive months of net inflows.¹ There were 5,401 U.S.-domiciled ETFs at the end of June 2026, according to Morningstar data.² The first U.S. ETF launched in 1993.

What does an ETF hold?

An ETF can hold almost any type of liquid asset. Common examples include:

Equity ETFs, which hold stocks, often tracking an index such as the S&P 500, a sector, a country or a theme.

Bond ETFs, which hold government, corporate or municipal bonds.

Commodity ETFs, which hold physical commodities or futures contracts.

Options-based ETFs, which combine holdings with options strategies, such as covered call and buffer funds. Our articles on covered call ETFs and buffer ETFs describe two of these.

Multi-asset ETFs, which combine several asset types.

Most ETFs disclose their full holdings every business day on their websites.

How do ETF shares trade?

Investors buy and sell ETF shares through a brokerage account during market hours, just as they would trade a stock. The price is set by supply and demand on the exchange and can change throughout the day. Investors can use the same order types available for stocks, such as market and limit orders. Our article on how to buy an ETF explains the process.

Most trading in ETF shares takes place between investors on the exchange. When one investor sells, another buys. The fund itself is not involved in those trades and does not need to buy or sell its holdings.

What is net asset value?

Net asset value, or NAV, is the value of an ETF’s holdings minus its liabilities, divided by the number of shares outstanding. ETFs calculate NAV once a day, typically at the market close.

The market price of an ETF’s shares and its NAV are related but not identical. During the day, the market price reflects what buyers and sellers are willing to pay. When the market price is above NAV, the ETF trades at a premium; when it is below, it trades at a discount. Our article on bid-ask spreads and premiums or discounts explains how to read these figures.

How does creation and redemption work?

Creation and redemption is the mechanism that allows an ETF’s share count to expand or shrink, and it helps keep market prices close to NAV.

Authorized participants. These are large financial institutions, typically broker-dealers, that have agreements with the ETF to create and redeem shares directly with the fund.

Creation. When demand for an ETF’s shares rises, an authorized participant can deliver a basket of the ETF’s underlying securities, or cash, to the fund. In exchange, the fund issues new ETF shares in large blocks called creation units. The authorized participant can then sell those shares on the exchange.

Redemption. When investors are selling, an authorized participant can return ETF shares to the fund in creation-unit blocks and receive the underlying securities, or cash, in exchange. The shares are retired.

Arbitrage. If an ETF’s market price rises meaningfully above the value of its holdings, authorized participants and market makers can buy the underlying securities, create ETF shares and sell them at the higher price, which tends to push the price back toward NAV. If the price falls below NAV, they can buy ETF shares, redeem them for the underlying securities and sell those, which tends to push the price back up. This activity is what generally keeps ETF prices close to the value of their holdings.

How do ETFs handle capital gains?

Because many ETFs meet redemptions by delivering securities in kind rather than selling them for cash, they can often avoid realizing capital gains inside the fund. That can reduce the capital gain distributions passed to shareholders compared with funds that must sell holdings to meet redemptions. Results vary by fund. ETFs that hold assets that cannot be delivered in kind, or that realize gains through their strategies, may still distribute capital gains. Investors should consult a tax advisor about their own situation.

How do ETFs differ from mutual funds?

Trading. ETF shares trade on an exchange throughout the day at market prices. Mutual fund shares are bought and sold directly with the fund once a day at NAV.

Minimums. ETFs can be bought one share at a time, and many brokers offer fractional shares. Mutual funds often have minimum initial investments.

Costs. ETFs have expense ratios and may involve trading costs such as bid-ask spreads. Mutual funds have expense ratios and may carry sales loads or other fees.

Transparency. Most ETFs publish holdings daily. Mutual funds generally publish holdings less frequently.

Capital gains. The in-kind redemption process often helps ETFs limit capital gain distributions.

What rules govern ETFs?

Most ETFs in the United States are registered investment companies under the Investment Company Act of 1940. In 2019, the Securities and Exchange Commission adopted Rule 6c-11, known as the ETF Rule, which created a standard framework for most ETFs and made it easier to launch new funds, including actively managed ETFs.³ Our article on active versus passive ETFs explains the two approaches. The rule also requires ETFs to disclose certain information on their websites, including holdings, premiums and discounts, and bid-ask spreads.

What are the risks?

ETFs carry the risks of the assets they hold. An equity ETF is exposed to stock market declines; a bond ETF to interest rate and credit risk. Specialized ETFs, such as those using options or leverage, carry additional risks described in their prospectuses. Market prices can also deviate from NAV, particularly in stressed markets or for funds holding less liquid assets. More introductory topics are covered in our ETF basics guide. Investments involve risk, including possible loss of principal.

Frequently asked questions

What does ETF stand for?

ETF stands for exchange-traded fund. It is an investment fund whose shares are listed and traded on a stock exchange. Each share represents an interest in the fund’s portfolio of stocks, bonds or other assets, and shares can be bought and sold during the trading day through a brokerage account.

What is the difference between an ETF’s price and its NAV?

NAV is the value of the fund’s holdings per share, calculated once a day. The market price is what buyers and sellers pay on the exchange, which changes during the day. Creation and redemption by authorized participants generally keeps the two close, though small premiums or discounts are common.

Who are authorized participants?

Authorized participants are large financial institutions that have agreements with an ETF to create and redeem shares directly with the fund in large blocks. Their ability to do so, along with the activity of market makers, helps align the ETF’s market price with the value of its holdings.

Are ETFs safer than individual stocks?

Many ETFs hold diversified portfolios, which can reduce the risk tied to any single company. However, an ETF is only as diversified as its holdings, and ETFs concentrated in a sector, theme or single stock can be volatile. ETFs are not insured or guaranteed and can lose value.

Do ETFs pay dividends?

Many do. ETFs pass through dividends and interest from their holdings, typically as periodic distributions. Some also distribute capital gains or option premium. The frequency and amount vary by fund. Our article on distributions versus dividends explains what a fund distribution can include.

Cite this page: Adam Patti, "What Is an ETF and How Does It Work?," VistaShares, updated November 13, 2026, https://www.vistashares.com/what-is-an-etf/. Plain-text version.

This material is provided for educational purposes only. It is not investment, legal or tax advice, and it is not a recommendation or an offer to buy or sell any security. Information is drawn from sources believed to be reliable as of the date of publication, is not guaranteed as to accuracy or completeness, and may change without notice. Figures attributed to third parties are their estimates. Projections and forecasts are not guarantees of future results. Investors should consult their own financial, legal and tax professionals before making investment decisions. Investments involve risk, including possible loss of principal. ETF shares are bought and sold at market price, which may differ from net asset value, and brokerage commissions and other trading costs may apply.