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Interested in ETFs but don’t quite know where to start? You’re not alone. Schwab has the answers you need to questions like "What are ETFs?" and "How do ETFs work?" and much more; all right here in this ETF learning center.
An ETF is an investment that holds a portfolio of securities, such as stocks or bonds, and trades like a stock. It can be a low-cost way to build a well-diversified portfolio. ETFs can give you diversified exposure to a particular segment of the market (large-cap U.S. stocks, for example), a specific industry, or a geographical region.
An ETF is a bit like a mutual fund and a bit like a stock:
  • Like a mutual fund, an ETF represents a basket of securities. Similar to index mutual funds, most ETFs provide exposure to a particular segment of the market by tracking an index, such as a broad market, sector, or regional index. When you buy an ETF, you’re getting exposure to all of the securities the ETF holds, which makes it easy to use ETFs to diversify your portfolio.
  • Like a stock, an ETF trades on a stock exchange, and you can buy or sell shares at any time during the trading day. The price is determined by supply and demand for the fund in the market. As with stocks, you typically pay a commission for each trade, although some brokers offer commission-free ETFs, including Schwab ETFs™ when traded online through a Schwab account.1
Here are some other benefits:
  • Potential tax efficiency. Unlike mutual funds, ETFs typically don’t need to sell their holdings to meet shareholder redemptions. This helps keep capital gains low. And since most ETFs track indexes, their holdings tend to have less turnover than actively managed mutual funds, which reduces distributions even more.
  • Transparency. Most ETFs disclose their holdings on a daily basis and update prices throughout the day, so you can see exactly what your ETF holds.
  • Expenses. ETFs typically have low expense ratios. The lower the expense ratio, the greater the portion of the fund’s returns that you get to keep.
  • Risk management. Although investing always carries risks, some risks can be reduced by diversifying across a wide range of securities and asset classes. ETFs make it easy to diversify because they generally invest in many individual securities, and you can mix and match ETFs to diversify across asset classes.
ETFs are a good choice for many investors, but they’re not right for everyone. Like most investments, ETFs are not FDIC-insured, and you can lose money if the market that they track experiences a downturn. If your primary objective is to preserve what you have rather than grow it or generate income, ETFs might not be the ideal investment for you.
Also, you typically pay a commission each time you buy or sell an ETF. If you are dollar-cost averaging, day trading, or making small investments, this can take a big bite out of your investment. An exception is Schwab ETFs, which trade commission-free online for Schwab clients1.
Although low expenses are one of the big draws of ETFs, there are several costs to keep an eye on.
  • Expense ratios. The expense ratio is the percentage of fund assets taken out annually to cover fund expenses. For example, if you have $10,000 in an ETF with a 0.25% expense ratio, you’re paying about $25 per year in 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.
  • Trade commissions. You’ll pay a commission each time you buy or sell an ETF. At Schwab, that commission is $4.95 per online trade,2 although Schwab ETFs trade commission-free online when traded in a Schwab account.1
  • The difference between market price and net asset value. The price you pay for an ETF will generally be close to the value of the underlying stocks or bonds in the fund, known as the net asset value (NAV). However, the market price can deviate from the NAV, meaning you might pay more (or less) than the underlying value per share. This discrepancy is more common in ETFs whose underlying holdings have low trading volume.
  • The difference between the bid price and the ask price. There is typically 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.
To narrow the field, start by getting to know the different types of ETFs.

Type of ETF Overview Pros Cons
Broad-Market ETFs Track broad-based market indexes, and are what most investors have in mind when they think of ETFs. Low-cost, highly diversified, and tradable intraday.  
Niche ETFs Track narrower sectors of the market, such as stock sectors, bond sectors, and single countries. Can be a good way to fill a specific gap in your portfolio. Offer less diversification and may have higher costs.
Exotic ETFs Track unusual strategies, such as commodities and currencies. Can be an easy way to get exposure to assets that are hard to invest in directly. Can be more expensive and are generally used only by experienced investors because of their potential for higher risk. 
Leveraged ETFs Managed to move up and down faster than the index they track—some may move three times as much as their index over the course of the trading day. Can be used for short-term investments based on a particular view of the market’s direction. Often volatile and can deviate from their underlying index, especially in the long term; investors should seek to understand them carefully prior to investing.
Inverse ETFs Managed to move in the opposite direction than the indexes they track; when the index goes up, they go down. Can be used as a short-term hedge against market exposure or to profit from market declines. Generally used only by experienced investors due to their risky nature.
Everybody’s different, of course, but these strategies will give you some ideas:
  • Building an all-ETF portfolio. You can construct a diversified portfolio by selecting a combination of ETFs that reflects your goals and tolerance for risk. For example, an investor might choose one ETF that covers the U.S. stock market, one for the international stock markets, one for fixed income, and maybe one for real estate, and with just a few trades, he or she would have a portfolio that’s well diversified across major asset classes.
  • Filling a single asset class. If you already have a portfolio of mutual funds and individual stocks but realize that you’re lacking exposure to one sector, you can use an ETF to quickly fill that gap.
  • Overweighting a promising area. If you like a particular segment of the market, such as a single country or sector, an ETF makes it easier to gain exposure without having to research and trade a lot of individual stocks or bonds. But do keep in mind that investments in individual sectors or countries can be volatile compared to those that are more diversified.
Schwab clients can go straight to our ETF Research Center to:
  • Search for ETFs based on a wide range of criteria, such as ratings, fund performance, and risk analysis.
  • Get our experts’ picks for ETFs across a wide variety of asset classes using our ETF Select List.
  • See up to three funds side by side and compare their performance, top holdings, and annual dividend yield.
  • Get a report card for any ETF and see historical price performance, fund strategy details, and ratings from Morningstar and other leading third-party experts.
ETFs trade a little differently from mutual funds. If you’re used to placing stock trades, then you’ll find that placing ETF trades is much the same. If you generally trade mutual funds, or if you’re new to investing, you’ll need to learn a little about placing ETF trades.

When you place an order for an ETF, you are buying or selling the shares through an exchange, such as the New York Stock Exchange. Your buy order is matched up with sell orders in the market. When a suitable match is found between a buy order and a sell order, the shares are exchanged. Unlike mutual funds, ETFs can be traded throughout the day rather than once a day after the market closes, and there are a variety of order types you can use, including market and limit orders.

There are different types of buy orders that you can place with your brokerage firm. The two most common order types are market orders and limit orders.

A market order tells the broker to buy the shares at the best available price in the market at the time the order is received.

Pros: Market orders are usually filled quickly.

Cons: Depending on market conditions, you might pay more for your shares than you expect.

Example: You might place an order hoping for a share price of $10.00, but if the best available price in the market is $10.03, then your order will be filled at that price.
There are different types of buy orders that you can place with your brokerage firm. The two most common order types are market orders and limit orders.

A limit order tells the broker to buy the shares only at, or below, a price that you specify.

Pros: You won’t pay more than you specify per share.

Cons: Your trade might take some time to be filled, or it might not be placed at all if the share price fails to fall to the level you specify.

Example: A $10.00 limit order will wait until it can be filled at $10.00 or less. If the market price stays above $10.00 over the life of the order, the order might never be filled.
When you place an order for an ETF, you specify how long the brokerage firm should try to fill your order before giving up and canceling it. Order timing is generally less important with market orders because they tend to be filled quickly, but it can be an important consideration for other order types, such as limit orders. The two most common order timing options are day only and good-till-canceled.

Day-only orders: This type of order stays in force only until the end of the market day (typically 4:00 p.m. ET). If the trade is not filled by the end of the market day, the order will be canceled.

Good-till-canceled orders: This type of order stays in force for an extended period (for 60 calendar days at Schwab). Your broker will try to fill your order throughout each market day during that period.

When choosing an ETF, remember that ETFs with higher trading volume are more liquid, so you are less likely to run into surprises with execution price or timing.
We can help with that too. When you choose one of our professionally managed ETF portfolios, we help you pick a portfolio strategy that meets your goals and risk tolerance, and then we monitor and maintain a portfolio of ETFs with an asset allocation that is appropriate for your strategy. It’s a way to get the benefits of ETFs with professional management at a reasonable cost.
Of course. Just call us anytime at 866-855-7728. We’re here to help you every step of the way. You can also drop by your local Schwab branch to talk with a Financial Consultant.

Take the next step.

Open an account at Schwab today to start saving on ETFs.

Open an Account Call 866-855-7728. Visit a branch.

Investors should consider carefully information contained in the prospectus or, if available, the summary prospectus, including investment objectives, risks, charges, and expenses. Please read it carefully before investing.