When you buy an investment that is based on an index, you invest in a broad variety of securities. For example, if you invest in an ETF that tracks the S&P 500® Index, your money is spread across the 500 companies that comprise the index. This means you also spread the investment risk among all the securities that comprise a particular index. Of course, diversification cannot assure a profit or protect against losses in the fund.
ETFs generally have lower operating expenses than mutual funds because most ETFs are not actively managed and, therefore, do not incur the internal costs of buying and selling securities. Similar to other investments available in the marketplace, there may be sales commissions associated with the purchase and sale of ETFs.
Unlike mutual funds, ETFs do not have annual capital gains distributions that are the result of the active buying and selling of securities in a fund. Instead, any gain is realized when you sell the ETF or there is a positive change in the value of the underlying securities in the index.