Tracking an Index
Most passively managed exchange-traded funds (ETFs) track an index, which means they are constructed to mirror the performance of the index. Each index is composed of stocks that are selected based on certain characteristics (often the company's size or industry), and an ETF tracking the index will usually be made up of the same stocks in the same proportion.
The goal of an index ETF is to match the performance of the index as closely as possible, not to out-perform it. The narrower the spread, the closer the fund is to achieving this goal.
Because ETFs do not seek to outperform the index they track, the funds are passively managed. Passive ETF managers will usually rebalance the fund only when something changes in the underlying index. This means two key things for investors:
The downside to mirroring an index's performance is simply that the ETF is at the mercy of the index. If the index falls, so will the value of the ETF tracking it.
Keep in mind, some ETFs may be actively managed; likewise, some mutual funds are passively managed. It is important to read the fund's prospectus to determine the manager's objectives before investing.
Investors should consider the investment objectives, risks, charges, and expenses of an Exchange-Traded Fund (ETF) carefully before investing. A prospectus contains this and other information about the ETF and can be obtained from the issuer. The prospectus should be read carefully before investing.