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.
ETFs are bought and sold like a common stock on a stock exchange.
Like a stock, ETFs are traded and experience price changes throughout the day.
ETFs generally hold a collection of stocks, bonds or other securities in one fund or have exposure to a single stock or bond through a single-security ETF.
What are potential benefits when investing in ETFs?
ETFs give you an efficient way to diversify your portfolio without having to select individual stocks or bonds.
With Schwab, online listed ETF trade commissions are US$0 per trade.1
ETFs are very versatile, letting you easily move money between specific asset classes, like stocks, bonds, or commodities.
Most ETFs disclose their holdings on a daily basis.
Due to typically lower turnover and the in-kind creation/redemption process, ETFs typically pass through fewer capital gains to U.S. investors, including expatriates.
What are some considerations when investing in ETFs?
Some brokerages charge you a commission when you buy or sell an ETF.
However, Schwab doesn't charge commissions for online ETF trades.1
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).
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.
Similarly, ETFs with lower liquidity tend to have larger bid/ask spreads.
Volatility may also affect premiums or discounts to net asset values, resulting in higher costs for the investor.
Some ETFs are complicated
Investors should carefully evaluate their features, risks, benefits, and performance characteristics in comparison to their 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 main categories of ETFs: equity ETFs, ETFs with complicated strategies, and non-equity ETFs.
TypeEquity ETFs>DescriptionThere 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 a thousand.>Examples
- International ETFs
- Sector ETFs
- Dividend ETFs
- Market-cap index ETFs
TypeETFs with complicated strategies>DescriptionThe 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
- Strategic ETFs
- Factor-based ETFs
- Fundamental ETFs
- ESG ETFs
- Active ETFs
TypeNon-equity ETFs>DescriptionIn addition to stocks, an ETF can hold non-equity securities, such as bonds, commodities, and currencies.>Examples
- Bond ETFs
- Commodity ETFs
- Currency ETFs
TypeNon-U.S. ETFs>DescriptionUndertakings 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. UCITS ETFs are intended only for non-US residents.>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:
You'll typically pay a commission each time you buy or sell an ETF at your brokerage company, but not always. Keep in mind, the smaller your investment and the more frequently you trade, the more impact these commissions will have on your bottom line. Standard trades at Schwab are $0 per trade online.1
Operating expense ratio (OER)
An OER is the percentage of fund assets deducted annually to cover fund expenses. For example, if you have invested US$10,000 in an ETF with a 0.16% annual expense ratio, about US$16 per year is deducted for operating expenses. It's a good idea to look at the expense ratio of an ETF before you buy. A small difference in annual expenses can add up over time.
There is normally a difference, or spread, between the bid price (the highest price a buyer is willing to pay for a share) and the ask price (the lowest price a seller is willing to accept for a share). The amount of the spread varies from one ETF to another, and tends to be greater for ETFs with low trading volume.
If you plan to hold an ETF for less than a year, this cost can matter more than the OER.
Why trade ETFs with Schwab?
US$0 online listed equity commissions
Build the core of your portfolio from over 2,000 commission-free1 listed ETFs.
Trade ETFs using our web, mobile, or advanced platforms.
Get real-time trade analysis and focused support from investing professionals.
Sharpen your instincts with actionable stock trading research and insights from Schwab and third parties.
There are several 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.
- Consider a limit order. Placing a limit order may be helpful to balance both execution and price. A limit order is an order to buy or sell an ETF with a restriction on the maximum price to be paid or the minimum price to be received (the "limit price"). If the order is filled, it will only be at the specified limit price or better. However, there is no guarantee of order execution.
- 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.
- Consider reaching out to a professional for trading assistance, especially on large orders. For example, if you ever need to trade a substantial number of shares of ETFs (such as tens of thousands of shares), call us and we may be able to assist you with our specially trained traders.
Schwab clients who are resident in the European Economic Area (EEA) or United Kingdom are not able to purchase U.S.-registered ETFs in order to comply with local regulations related to PRIIPS (Packaged Retail Investment & Insurance Products).
These rules govern the sale of certain investment products to residents in the EEA and UK. As a result of these rules, residents in these countries may only hold or liquidate existing U.S. exchange traded product positions. Initial or additional purchases are not permitted.
As an alternative, Schwab offers ETFs that have been authorized as Undertakings for Collective Investment in Transferable Securities (UCITS) under EU and UK rules. These funds meet relevant regulatory requirements, offer investment strategies similar to those of their U.S. counterparts and are available to EEA and UK resident investors. Many UCITS rules are aimed at reducing the risk by safeguarding the way investment products are managed and controlled. UCITS rules also require an ETF to be liquid, and always accessible. UCITS ETFs are subject to a US$50 foreign transaction fee and must be placed by phone with the help of a Schwab Global Investing Services specialist.
Because of the unique structure of ETFs and the majority of ETFs being passive investments (although actively managed ETFs are also available), capital gains distributions can be lower and there tends to be less portfolio turnover.
This information is general in nature and is not intended to be a substitute for specific individual tax advice. Investors should consider the implications of taxation in their jurisdiction based on their own individual circumstances and bear in mind that rules on taxation can change at any time. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor.
Investing in U.S. securities is not without risk. Investment returns will fluctuate and are subject to market volatility, so that an investor’s shares, when redeemed or sold, may be worth more or less than their original cost.
If the index that your ETF tracks experiences a downturn and you decide to sell, you will likely lose money on your investment. 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.
There are over 2,000 ETFs available. Utilize the Schwab tools to help select an ETF.
- If you're looking for commission-free ETFs, consider listed 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 2,000 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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