ETFs, in the simplest terms, are funds that track indexes like the NASDAQ-100 Index, S&P 500, Dow Jones, etc. When you buy shares of an ETF, you are buying shares of a portfolio that tracks the yield and return of its native index. The main difference between ETFs and other types of index funds is that ETFs don’t try to outperform their corresponding index, but simply replicate its performance. They don’t try to beat the market, they try to be the market.
The purpose of an ETF is to match a particular market index, leading to a fund management style known as passive management. Passive management is the chief distinguishing feature of ETFs and it brings a number of advantages for investors in index funds. Essentially, passive management means the fund manager makes only minor, periodic adjustments to keep the fund in line with its index. This is quite different from an actively managed fund, like most mutual funds, where the manager continually trades assets in an effort to outperform the market. One of the main advantages of an ETF is that because it tracks an index without trying to outperform it and it incurs fewer administrative costs than actively managed portfolios. Typical ETF administrative costs are lower than an actively managed fund.