The definitions of ETFs already provided are fine, but the point is understanding how they’re used in a portfolio. ETFs can be very beneficial because they are an inexpensive way to buy a basket of related stocks, bonds, or commodities. Buying the basket is usually less risky than buying just a few stocks, and it’s appropriate for most of us, because we don’t have the financial resources to take big risks with our savings.
The other good thing about ETFs is that now there are so many of them (more than 1000 by last count) that an investor can target his or her resources into specific areas, if that’s what you want to do. So you can buy an oil industry or a healthcare ETF; a real estate or commodities ETF; or an ETF that invests only in businesses in California.
The possibilities are expanding every day. By using ETFs, you can not only gain diversification, but you can also make a targeted “bet” on a particular market, if you feel you have superior knowledge about that market.
Of course, one can also argue that the plethora of new ETFs is being developed just to goad suckers into buying these rather useless, exotic investments. For a good primer on ETFs, buy the book “ETFs for Dummies” and read some stuff online, like the weekly blog “ETF Watch” on www.indexuniverse.com.