By Paul Feeney, Founder and Chief Executive Officer, Otivo
There's a neat trick at the heart of an ETF. You buy a single unit on the exchange, the same way you'd buy one share, and behind the scenes that unit quietly represents hundreds or even thousands of underlying investments. How that trick works, how the price stays honest, and how the money finds its way to you is worth understanding before you buy in. Here's what's happening under the bonnet.
An ETF works by holding a basket of assets and issuing units that trade on an exchange. Buying a unit gives you a proportional share of everything the fund holds. Most track an index, aiming to match its performance rather than beat it. As at July 2026, you buy and sell ETF units through a broker during market hours, much like shares.
How does an ETF hold its investments?
Behind each ETF sits a pool of actual investments, the shares, bonds or other assets the fund owns. The fund issues units that each represent a proportional claim on that pool, so owning units means owning a slice of everything inside. Most ETFs are built to track an index, meaning they hold the same investments as a chosen benchmark in the same proportions. The fund's job is then simply to mirror that basket, rather than to make active bets on which holdings will do best.
How do you buy and sell an ETF?
You trade ETF units through a broker, on the exchange, during market hours, exactly as you would with shares. When you place an order, you're buying units from or selling them to other participants in the market at the current price. That's a key practical difference from a traditional managed fund, which you typically buy directly from the fund manager at a price struck once a day. With an ETF, the price moves through the trading day and you deal at the market.
What does it mean that an ETF tracks an index?
Tracking an index means the fund aims to match the performance of a benchmark rather than beat it. If the index it follows rises 7% over a year, a well-run tracking ETF aims to deliver close to that, minus its costs. This is often called passive investing, since no one is actively choosing which holdings to favour. The appeal is low cost and predictability of approach, you know the fund is trying to be the market, not outguess it.
How does the ETF price stay close to the value of its holdings?
This is the clever part. Specialist market participants can create new ETF units by delivering the underlying assets to the fund, or redeem units in exchange for those assets. That mechanism means if an ETF's price drifts too far from the value of what it holds, there's an incentive to trade the gap away, nudging the price back into line. The result, most of the time, is that an ETF's market price stays close to the underlying value of its basket.
How do you earn a return from an ETF?
Two engines drive an ETF return. The first is price growth, if the value of the underlying holdings rises, the units are generally worth more. The second is distributions, the income the fund passes through when the shares or bonds inside it pay dividends or interest. Together, growth and distributions make up your total return, and like any market investment, both can vary and the value can fall as well as rise.
Frequently asked questions
Do I need a broker to buy an ETF?
Generally yes. Because ETFs trade on an exchange, you buy and sell units through a brokerage account, the same way you would with shares. The broker executes your order at the market price.
What does it mean to track an index?
It means the ETF aims to match the performance of a chosen benchmark rather than beat it, holding the same investments in the same proportions. This passive approach is what keeps many ETFs low cost.
How is an ETF priced?
An ETF trades at a market price through the day, and a creation and redemption mechanism keeps that price close to the value of the fund's underlying holdings. This differs from a managed fund priced once daily.
Where to from here
Knowing how ETFs work is one piece, fitting them into your overall plan is another. Otivo, a licensed Australian financial advice platform holding AFSL and Australian Credit Licence No. 485665, offers a retirement planning module that can account for investments outside super in your broader position, based on your age, income, balance and goals. It helps you see how the pieces work together.
Sources
- ASIC MoneySmart — how exchange traded funds work — moneysmart.gov.au
- Australian Securities Exchange — ETF trading and structure — asx.com.au
Disclaimer
The information in this communication is current as at July 2026 and has been prepared by Otivo Pty Ltd ABN 47 602 457 732, AFSL and Australian Credit Licence No. 485665. This content is general information only and has been prepared without taking into account your objectives, financial situation or needs. It is not personal financial or taxation advice and should not be relied on as such. Before acting on any information, you should consider its appropriateness having regard to your personal circumstances. This material must not be reproduced in whole or in part, or posted on any social media platform, without the prior written consent of Otivo Pty Ltd.