ETF FAQs: Common Questions About ETF Investing

by on March 12, 2009 | Updated May 26, 2014

What is an ETF?
An exchange-traded fund is an investment vehicle that trades on an exchange. Like a mutual fund, an ETF is a bundle of securities, but instead of being priced based on net assets at the end of each trading day, ETFs are listed on intraday trading exchanges and can be bought and sold throughout the day. Most ETFs are index funds that passively track a benchmark.

How do I buy and sell ETFs?
They can be traded just like stocks at any brokerage firm. We recommend an online-friendly, discount brokerage firm, like Scottrade or Zecco.

What are the advantages of index ETFs over index mutual funds?
There are two reasons why index ETFs are often better than index mutual funds: 1) The management fee and expense ratio of mutual funds usually exceed that of an ETF (check out the ETFs with the lowest expense ratios); 2) ETFs allow for intraday trading, whereas mutual funds do not.

Shouldn’t I be trying to outperform an index instead of matching it?
Numerous studies have shown that on average, actively managed mutual funds generally underperform their benchmarks (after taking management fees into account).

Are ETFs guaranteed or insured?
The creation and redemption processes of ETFs are heavily regulated by the Securities and Exchange Commission as well as the Depository Trust Clearing Corporation. To the best of our knowledge, there has never been a case of an investor losing money in ETFs due to fraud. That said, the underlying assets of ETFs are an entirely separate matter. All ETFs carry risk of value loss, just like any investment. Stock ETFs and commodity ETFs can be risky, while investment-grade bond ETFs are generally safer.

Are ETFs only for stocks?
No. If there’s a liquid asset class with an index published around it, there’s likely and ETF for it already. Bond, commodity, currency, and real estate ETFs, and are the other asset classes for which ETFs are available. There are even some multi-asset ETFs.

Are there international ETFs?
Yep, those are also available. Regional funds such as Asian or European ETFs are in existence too.

What is the minimum-sized ETF purchase?
Investors can purchase as little as one share.

What are the benefits of ETFs trading as stocks?
There are several advantages to this, including: the ability for intraday trading, buying on margin, and short selling.

Are there tax benefits to owning ETFs?
Since most ETFs are designed to track an index, they usually are subject to much lower turnover than an actively-managed mutual fund, which reduces the frequency of tax gain distributions. (More info on ETFs and taxes)

How does the performance of an ETF compare with its underlying benchmark?
ETFs are designed to trade at a price close to its underlying benchmark index. Arbitrage traders in the secondary market limit the gap in price between the ETF and its benchmark. Although, because of numerous market forces, there are often times where the ETF will trade at a slight discount or premium to its benchmark.

Can ETFs be purchased on margin or short sold?
Yes. This is one of the advantages of ETFs trading on intraday exchanges.

Do ETFs pay dividends?
Yes, holders of ETFs are eligible to receive their share of dividends issued by the funds’ underlying stocks, less any expenses and other fees. And like stocks and mutual funds, there may be dividend reinvestment opportunity.

What are the differences between mutual funds and ETFs?
ETFs are bought and sold through a brokerage account and offer intraday trading liquidity. Conversely, mutual funds may be purchased directly from the mutual fund provider or through a brokerage and are only bought and sold on their Net Asset Value (NAV), which is determined at the end of each trading day.

What are the differences between stocks and ETFs?
Individual stocks and ETFs trade alongside each other on the intraday stock exchanges. But there are two major differences: 1) ETFs generally are much more diversified, as they comprise baskets of stocks, bonds, or commodities; 2) Most ETFs track specific indices, whereas stocks do not.