25 Years in, How Have ETFs Evolved Over Time?

February 9, 2022

In the past decade, money invested in exchange-traded funds has quintupled from $1 trillion to $5 trillion globally, and ETFs listed on the U.S. exchanges recently surpassed the $4 trillion mark.

Which is even crazier when you remember that 25 years ago, ETFs didn’t exist.

Of course, like all investment vehicles, ETFs have evolved since their original conception. How have ETFs evolved—and how have they forced major evolution in the investment market? Here’s a retrospective and a look ahead.

What is an ETF?

25 years in, the basics of an ETF remain more or less the same.

An exchange-traded fund, or ETF, is a basket of securities that you can buy or sell on the stock exchange as if the entire basket is a single stock. The whole basket tracks an index, sector, commodity, or asset—some ETFs are even structured to track specific investment strategies. Some focus on country-specific holdings, while others are international.

Regardless of what the ETF tracks, it can contain a variety of investments, including:

  • Stocks
  • Bonds
  • Commodities
  • A mixture of investments

Regardless of what’s in the ETF, all ETFs are considered marketable securities, which means it has an associated price that makes it easy to buy and sell just as quickly as an individual stock. And because ETFs trade like stocks, they can be bought and sold throughout the trading day and experience price fluctuations based on that activity (as opposed to mutual funds, which can only trade once per day before the market closes).

How ETFs Work

Think of an ETF as a blend of sorts between an index fund and a company. In fact, many of the best-known ETFs track indexes, like the SPDR S&P 500 ETF, which tracks the S&P 500 index.

Let’s say you have an ETF. Each ETF fund provider owns the underlying assets contained in the fund. It then builds a fund to track the performance of those assets and allows investors to purchase shares in the fund.

Unlike an index fund, investors don’t own shares in the underlying asset, but they can get dividend payments just like owning a dividend-paying stock, and they can get reinvestments for stocks that make up the index.

Keep in mind that ETFs trade at market-determined prices that often differ from the asset they track, despite the fact that the whole fund is designed to track the value of an underlying asset or index. Plus, because the fund has management fees (low, but still present), ETF long-term returns won’t perfectly match the returns you might have achieved by owning the underlying asset outright.

Types of ETFs

Because ETFs can track a variety of assets, there are several different types of ETFs to choose from. These include:

  • United States market index ETFs
  • Foreign market index ETFs
  • Foreign currency ETFs
  • Commodity ETFs
  • Sector and industry ETFs
  • Investment style ETFs
  • Bond ETFs
  • Inverse ETFs
  • Leveraged ETFs
  • Actively managed ETFs
  • Dividend ETFs
  • Exchange-traded notes
  • Alternative investment ETFs

That’s great news for investors. It means that ETFs offer a surprisingly diverse and robust array of investment options, and you can choose an ETF option that works well based on your assets of choice and your investment goals.

How Have ETFs Evolved?

So, how have ETFs evolved since they first hit the market 25 years ago? To understand that, it pays to take a look back at the early days—and where ETFs are now.

The First ETF

ETFs began as an outgrowth of index investing, though modern ETFs bear little resemblance to the trusts and closed-end funds that eventually inspired ETFs.

The first seed of ETFs began when American National Bank and Wells Fargo both launched mutual funds in 1973 for institutional customers in response to academic research on the benefits of passive investing. A few years later, John Bogle followed suit with the First Index Investment Trust on December 31, 1975, a fund that tracked the S&P 500 and began with a mere $11 million in assets. The assets in that fund are now known as the Vanguard 500 Index Fund, and they were valued at roughly $441 billion when Bogle died in 2019.

Either way, the public showed it had a preference for indexed investing, and the first genuine attempt at an ETF was the Index Participation Shares for the S&P 500 in 1989. It took until 1993 for ETFs to fully take root when State Street Global Investors announced the S&P 500 Trust ETF (called the SPDR) on January 22, 1993—and that fund remains one of the most actively traded ETFs on the market today. Still, it took another 15 years for the first actively managed ETF to hit the market.

ETFs Today—and How ETFs Have Changed Investing

Today’s ETFs look rather different from those early efforts. And they’ve done a great deal to rewrite the investment landscape.

In the early days, ETFs had more in common with mutual funds. These days, they’re more like a cross between an index fund and a company. They also bear precious little resemblance to the index investing strategy that inspired them, wherein investors use a buy-and-hold strategy to replicate the performance of a market index.

Many average investors now rely heavily on ETFs, as ETFs are the tool of choice for passively managed portfolios crafted by robo-advisors. They provide rapid diversification and the ability to sell quickly, yet because the whole basket trades like an individual stock, it’s quite easy for a robo-advisor to maintain a stable of ETFs.

Smart Investment Options to Strengthen Your Portfolio

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