Understanding ETFs

Combining the flexibility of stocks and the portfolio-diversifying strengths of mutual funds, ETFs give you an affordable way to access a wide variety of asset classes.

What are ETFs?

ETFs or "exchange-traded funds" are exactly as the name implies: funds that trade on exchanges, generally tracking a specific index. When you invest in an ETF, you get a bundle of assets you can buy and sell during market hours—potentially lowering your risk and exposure while helping to diversify your portfolio.

Exchange

ETFs are bought and sold like a common stock on a stock exchange.
Traded

Like a stock, ETFs are traded and experience price changes throughout the day.
Funds

Similar to a mutual fund, ETFs are a collection of tens, hundreds, or sometimes thousands of stocks or bonds in a single fund.

What are potential benefits when investing in ETFs?

Diversification

ETFs give you an efficient way to diversify your portfolio without having to select individual stocks or bonds.
Low cost

With Schwab, online ETF trade commissions are US$0 per trade.
Trading flexibility

ETFs are very versatile, letting you easily move money between specific asset classes, like stocks, bonds, or commodities.
Transparency

Most ETFs disclose their holdings on a daily basis.
Tax efficiency

Due to typically lower turnover and the in-kind creation/redemption process, ETFs typically pass through fewer capital gains to U.S. expatriates.

What are the considerations when investing in ETFs?

Commissions

Some brokerages charge you a commission when you buy or sell an ETF.

However, Schwab doesn't charge commissions for online ETF trades.
Spreads

On top of commissions, investors also pay the "spread" when buying or selling ETFs, the difference between the higher price you pay to acquire a security and the lower price at which you can sell it.
Premiums and discounts

Investors may pay more for an ETF than the value of its underlying stocks or bonds (a premium). Conversely, investors may sell an ETF for less than the value of its holdings (a discount).
General liquidity

ETFs with higher liquidity can shrink bid/ask spreads since the more interested market makers there are, the closer the highest and lowest offered prices to sell are likely to be.
Market volatility

Volatility may also affect premiums or discounts to net asset values, resulting in higher costs for the investor.
Some ETFs are complicated

Because certain ETFs may be more complex based on their strategies or holdings, you should carefully evaluate their features, risks, benefits, and performance characteristics in comparison to your goals and expectations.

Types of ETFs.

There are a vast number of ETF choices on the U.S. market today. To determine which ones are right for your portfolio, it's helpful to look at common ETF types, the investment strategies associated with them, and their benefits, risks, and costs.

Let's take a closer look at the three main categories of ETFs: equity ETFs, ETFs with complicated strategies, and non-equity ETFs.

Descriptions and examples of various types of ETFs.

Type
Description
Examples

Type

Equity ETFs
Description

There is a wide array of equity ETFs to choose from, so knowing about the various subtypes can help you find one that fits your portfolio. Depending on the index tracked by the ETF, it may own stocks issued by companies from around the world or it may limit its investable universe to companies in the United States. Some ETFs allow companies of all styles and sizes, while others limit their holdings based on the particular characteristics of a company. Because there are so many variables, the number of stocks held by an ETF can range from less than 25 to over 7,000.
Examples
- International ETFs
- Sector ETFs
- Dividend ETFs
- Market-cap index ETFs

Type

ETFs with complicated strategies
Description

The number of strategies offered by ETFs has proliferated in recent years. While an ETF with a particular strategy may be exactly what you want in your portfolio, keep in mind that some strategies can be quite complex. It's a good idea to make sure you understand the process an ETF uses to select and weight securities before you make an investment decision.
Examples
- Smart beta ETFs
- Factor-based ETFs
- Fundamental ETFs
- Socially conscious ETFs

Type

Non-equity ETFs
Description

In addition to stocks, an ETF can hold non-equity securities, such as bonds, commodities, and currencies.
Examples
- Bond ETFs
- Commodity ETFs
- Currency ETFs

Type

Non-U.S. ETFs
Description

Undertakings for Collective Investment in Transferable Securities (UCITS) are a packaged investment product authorized in the E.U. They meet relevant E.U. requirements and offer investment strategies similar to those of their U.S. counterparts. U.S. residents can NOT purchase non-U.S. ETFs.
Examples
- UCITS ETFs

What do ETFs cost?

Many ETFs can be inexpensive, but as with all investments, you should be aware of the costs. Here are the costs most commonly associated with ETFs:

Trade commissions

The fees your brokerage company charges each time you buy or sell an ETF, which can range from US$0-US$20 per trade¹ for online trades, depending on the number of trades. Standard trades at Schwab are US$0 per trade online.²
Operating expense ratio (OER)

The ongoing management fee charged for an ETF by the fund's sponsor. This can vary widely, with the industry asset-weighted average** OER for passively managed ETFs being 0.21%³.

The asset-weighted average OER for cap weighted Schwab ETFs*** is just 0.05%.⁴
Bid/Ask spreads and premiums

Trading costs can also include two misunderstood and sometimes overlooked items: Bid/Ask spreads and changes in discounts and premiums to an ETF's net asset value (NAV).

Why trade ETFs with Schwab?

US$0 online equity commissions

Build the core of your portfolio from over 2,000 commission-free² ETFs.
Intuitive platforms

Trade ETFs using our web, mobile, or advanced platforms.
Trading specialists

Get real-time trade analysis and focused support from investing professionals.
Premium research

Sharpen your instincts with actionable stock trading research and insights from Schwab and third parties.

See More Reasons to Trade at Schwab

Common questions

How can I use ETFs in my portfolio?

There are three main ways you can use ETFs:

To achieve broad portfolio diversification.
To fill an asset-class gap in your portfolio.
To invest in a specific part of the market (as part of an overall balanced portfolio strategy). The path you choose should be determined by the target asset allocation you've identified for your portfolio.

How do I trade ETFs effectively?

Once you're ready to trade an ETF:

Consider placing a marketable limit order. This will help you balance both execution and price. When you are buying an ETF, this is a limit order where you specify a price equal to or greater than the posted offer price (but no higher than what you are willing to pay). That way, your order is likely to get filled immediately if the market doesn't move, and you avoid the risk of paying far more than you intended.
Be cautious about trading at market open or close. Markets can be unpredictable early and late in the day, and you may find yourself buying high or selling low. Also, consider when the markets for the underlying securities in the ETFs are open, especially if you're trading international stock and bond ETFs.
Get professional help with big orders. If you ever need to trade a substantial number of shares of ETFs (such as tens of thousands of shares), call us and we will connect you with specially trained traders. They may be able to have new shares created for you, which means you could enjoy better pricing.

What are the potential tax benefits?

Because of the unique way that ETFs are structured and because their holdings tend to have less turnover than actively managed funds, capital gains distributions can be lower, especially for stock ETFs.

What are the risks?

Like most investments, ETFs are not FDIC-insured. If the index that your ETF tracks experiences a downturn and you decide to sell, you will likely lose money. Not all ETFs carry the same risks; some ETFs, including inverse, leveraged, and futures-linked ETFs, carry additional risks and are not appropriate for all investors.

How do I pick an ETF?

There are over 1,200 ETFs available. Schwab can help you find the right one for your portfolio.

If you're looking for commission-free ETFs, consider Schwab ETFs. Each of these Schwab-created ETFs provides exposure to an asset category, and offers low expense ratios and US$0 online trade commissions through a Schwab account.¹ Learn more about Schwab ETFs.
If you know what type of ETF you want—traditional (domestic, international, or bond), specialty, or sector—take a look at the ETF Select List^®. This carefully compiled list represents our experts' top ETF picks based on criteria that include cost of ownership, risk, fund structure, and how well it fits in its category. Use the ETF Select List^®.
If you're looking for a specific ETF, consider using Schwab's ETF Screener. You can select from a range of different criteria or use our predefined screens to filter the entire marketplace of over 1,200 ETFs to find the one that's right for you. Use Schwab's ETF Screener. Learn more about what to keep in mind when choosing an ETF.
If you're looking to create your own portfolio, consider using the Schwab ETF Portfolio Builder^®. ETFs used in this tool are from the ETF Select List^®.

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Understanding ETFs

What are ETFs?

Exchange

Traded

Funds

What are potential benefits when investing in ETFs?

Diversification

Low cost

Trading flexibility

Transparency

Tax efficiency

What are the considerations when investing in ETFs?

Commissions

Spreads

Premiums and discounts

General liquidity

Market volatility

Some ETFs are complicated

Types of ETFs.

What do ETFs cost?

Trade commissions

Operating expense ratio (OER)

Bid/Ask spreads and premiums

Why trade ETFs with Schwab?

US$0 online equity commissions

Intuitive platforms

Trading specialists

Premium research

Common questions

Start investing in the U.S. today.

Start investing in the U.S. today.

Have more questions? We're here to help.

Call

Email

Mailing address