What is an ETF (exchange-traded fund)? The complete guide

ETF (Exchange Traded Fund), in Hebrew "keren sal" — in Israel the previous version was called "teudat sal" — is a fund that holds a whole basket of assets, usually one that tracks an index, and trades on the exchange exactly like a stock. Buying one unit buys exposure to the whole basket: hundreds of stocks in a single action, at the price of a stock.

On this page: how the mechanism works, why "small" expense ratios are actually a big deal, how an ETF differs from a mutual fund, and why leveraged funds belong in a completely separate category. Stated upfront: this is educational content only, and does not constitute a recommendation for any product.

How it actually works

An ETF holds the assets of the index it tracks — for example, hundreds of stocks from a broad index — and issues units that trade on the exchange throughout the trading day. Behind the scenes, a creation and redemption mechanism operates: institutional entities exchange baskets of stocks for fund units and vice versa, and simple arbitrage keeps the unit price close to the value of the assets inside (NAV). In large, liquid funds the gap is usually tiny; in small funds, or in moments of market stress, it can widen.

The result: broad diversification, transparency (the fund's holdings are published), and stock-like liquidity. What diversification does not do — covered in the last section.

Expense ratio: the small number that accumulates

The expense ratio (Expense Ratio) is charged as an annual percentage of assets and is built into the unit price — you won't see a charge on your account. The difference between 0.05% and 1% sounds cosmetic, but on 100,000 NIS that's a gap of almost 1,000 NIS a year, charged again every year, from an amount that was supposed to keep working on its own. Over two decades the cumulative gap reaches a significant portion of the portfolio — and it's charged in every market scenario, including red years.

Alongside the expense ratio there are quieter costs: the bid-ask spread (Spread), the broker's trading commissions, and in tracking funds — tracking error, the gap between the fund's performance and the index itself. A cheap fund that tracks sloppily can actually cost more than a slightly more expensive fund that tracks well.

How this differs from a mutual fund

Both instruments hold a basket of assets for a public of investors; the differences lie in the mechanics:

• Trading: An ETF is bought and sold throughout the day at a changing market price; a mutual fund — once a day, at a rate set at the end of the day.
• Transparency: A tracking ETF publishes its holdings; in actively managed funds, the holdings are published with a delay and less frequently.
• Management and cost: Most ETFs are passive (index-tracking) and therefore cheap; most mutual funds are actively managed and charge more. These are generalizations — there are exceptions on both sides.
• Method of purchase: An ETF is bought through a trading account like a stock; a mutual fund is bought through the bank's or broker's distribution system.

Leveraged funds: same name, different product

A leveraged ETF (x2, x3) delivers the multiple on the daily return only, and the daily reset creates erosion during volatile periods: the index can return to its starting point while the leveraged fund remains behind. These are tools for short, focused trading — not an "upgraded" version of a regular fund, and the price of holding them long-term is this erosion. The full account, with the numerical example, is found in the leverage guide.

What this doesn't mean

An ETF is probably the most recommended-in-living-room-conversations financial product — and precisely because of that, it's worth being precise about what it isn't:

• Diversification is not immunity: A fund on a broad index diversifies away single-company risk, but is fully exposed to declines of the entire market. When the index falls 20% — so does the fund. The broader connection is found in the market regime guide.
• "Passive" doesn't mean "without decisions": Choosing the index, the fund's currency, the dividend policy (accumulating or distributing), and the fund's structure are decisions with consequences — including tax consequences that depend on personal circumstances, and are not a matter for this guide but for a qualified professional.
• Tracking is not identical to the index: Expense ratios and tracking error create a gap. Usually small — but it exists, and accumulates.