General Questions

What are Exchange Traded Funds (ETFs)?

Exchange traded funds (ETFs) are an emerging class of low-cost index funds (ordinary commissions apply) that trade like stocks. In the U.S., ETFs can be found on the American Stock Exchange, the New York Stock Exchange, or the NASDAQ. ETFs are listed and traded intraday. ETFs allow investors to buy or sell shares in the collective performance of an entire stock or bond portfolio as a single security. Exchange traded funds add the flexibility, ease and liquidity of stock trading to the benefits of traditional index fund investing.

How long have ETFs been around?

ETFs date back to 1993, when the American Stock Exchange launched the S&P Depositary Receipts, Trust Series 1 (SPIDERS). The underlying index tracks the S&P 500.

How do I buy or sell ETFs?

Just like individual stocks, ETFs are listed and traded with ticker symbols. They can be bought or sold through a full service, or discount broker/dealer. A brokerage commission will usually apply when ETFs are bought or sold.

What is the minimum size purchase of an exchange traded fund?

Investors can purchase as little as one share.

Why invest in an index?

Indexing, or "passive management," involves investing in a group of securities that represent the composition of a broad market, industry sector, international stock, or U.S. bond index. Index funds offer "market level" performance, meaning they seek to generally match the performance of a specific index.

What are the benefits of exchange traded funds trading as stocks?

The unique "exchange traded" structure offers several advantages to ETF investors:

  • Buy and sell at any time during the trading day
  • Instantly get exposure to a portfolio of stocks or bonds
  • Buy on margin
  • Sell short, even on a downtick
  • No sales load, although brokerage commissions will apply
  • Lower fees
  • Tax efficiencies

How much do ETFs cost?

There are a number of factors that affect the cost of an ETF, including the expense ratio, and the brokerage commission to acquire the fund. Generally, the expense ratios of ETFs are consistently lower versus actively managed mutual funds. Specialty ETFs that track narrower indices tend to be more expensive than broad-based ETFs.

Can exchange traded funds be purchased on margin?

Exchange traded funds may be purchased on margin, and are subject to the same terms that apply to common stocks. Investors should contact their broker regarding initial, and maintenance margin requirements.

Can exchange traded funds be sold short?

Yes. All exchange traded funds may be sold short, representing the sale of "borrowed" shares in anticipation of lower prices. ETFs are exempt from the rule that requires shares to be sold short on a plus or zero plus tick (i.e., a sale price higher than the last different regular way sale in the security). Investors are required to make arrangements to borrow securities before selling short.

Is there a sales load on exchange traded funds?

While exchange traded funds are not subject to sales loads, usual brokerage commissions for securities purchases and sales will apply.

Are ETFs liquid investments?

Yes. Liquidity is generally considered an advantage of ETFs, but it is important to understand that the liquidity of an ETF is largely determined by the liquidity of the underlying stocks or bonds in its index, rather than by the trading volume of the fund itself. This is because it is easier for authorized participants or market makers to assemble creation units for liquid stocks or bonds. (Creations units are baskets of underlying stocks or bonds within an ETF that can be exchanged for ETF shares.) As a result, it is possible for ETFs with low trading volume to be liquid.

Do ETFs pay dividends?

The dividends received from underlying stocks in an ETF’s portfolio are distributed to fund shareholders. The frequency of dividend payments can be quarterly, monthly, or annually, depending on the fund.

What indexes do ETFs track?

Exchange traded funds track the performance of a variety of broad based and narrow stock, bond, and commodity indexes.

What market risks are associated with ETFs?

ETF investments have risks similar to stocks, including the possible loss of money. For a complete description of the risks associated with owning ETFs, please read the Principal Risks disclosure.

What’s the difference between the market price and NAV of an ETF?

Net Asset Value (NAV) refers to a fund’s total assets minus its liabilities, whereas market price refers to the quoted price that an ETF is trading at on an exchange. At times, the NAV and market price of ETFs will diverge. It is possible to pay more than NAV when purchasing shares of an ETF, and to receive less than NAV when selling shares.

ETFs vs. Closed End Funds

How are ETFs and closed-end funds different?

Since ETFs are index funds, they generally trade closer to their net asset value (NAV). In contrast, closed-end funds are usually actively managed and often employ leverage. This makes it more likely that a closed-end fund will trade at a premium or discount its NAV due to supply and demand of the fund’s shares.

How are ETFs and closed-end funds similar?

Both ETFs and closed-end funds are listed and traded with ticker symbols on a stock exchange. Investing in both will usually result in brokerage commissions. Information on specific fees, charges, and expenses can be obtained in the fund prospectus.

How does the cost of closed-end funds compare to ETFs?

The expense ratios of ETFs are generally lower versus closed-end funds. Since ETFs are indexed portfolios, the cost of managing them is less compared to actively managed portfolios. Investing in both ETFs and closed-end funds will usually result in brokerage commissions. Information on specific fees, charges, and expenses can be obtained in the fund prospectus.

ETFs vs. Mutual Funds

Are mutual funds better than ETFs?

Not necessarily. Each financial product has its strengths and weaknesses. Any fair comparison should be done in the context of not just performance, but tax efficiency, fees/total ownership costs, risks, structural differences of each product, and if the fund objectives match the financial objective(s) of a particular investor. Always refer to a prospectus for detailed information before investing.

Are mutual funds less risky to own than exchange traded funds?

Not necessarily. ETFs, like mutual funds, come in a variety of shapes and sizes. The level of risk in an ETF or mutual fund is determined by the portfolio holdings within the respective fund. Both mutual funds and ETFs can track a variety of indexes and sectors. Some indexes or sectors will be more volatile than others. However, there is no substantiated research to prove that ETFs are any more or less risky compared to mutual funds.

How does the cost of mutual funds compare to ETFs?

Generally, investors buying or selling ETFs will pay a transaction commission to a broker, whereas investors buying or selling no-load mutual funds directly from a fund company pay none. However, some brokers impose a commission to buy or sell no-load mutual funds. Other so-called “no transaction fee” mutual funds don’t charge a commission to buy, but often carry higher expense ratios.

Ultimately, any fair cost analysis between ETFs and mutual funds should look at the total spectrum of expenses, not just the transaction fee to acquire the ETF or mutual fund. Pay close attention to the expense ratio, portfolio turnover, and tax efficiency of a mutual fund versus an ETF. Always refer to a prospectus for detailed information before investing.

ETFs vs. Stocks

How are individual stocks different from ETFs?

While ETFs and individual stocks often trade along side one another on the various stock exchanges, they are not the same. ETFs are generally more diversified, since they are composed of groups or baskets of stocks, bonds, or commodities. Also, ETFs track specific indexes, whereas individual stocks do not.

How are individual stocks similar to ETFs?

Like individual stocks, ETFs can be leveraged with margin, shorted, or held long. Also, both are listed and traded on stock exchanges.

Are individual stocks better than ETFs?

Not necessarily. Each has its strengths and weaknesses. In addition to performance, any fair comparison should consider tax efficiency, fees/total ownership costs, risks, and if the fund or stock objectives match the financial objective(s) of a particular investor. Always refer to a prospectus for detailed information before investing.

ETFs & Taxes

How are ETFs taxed?

ETFs are required to distribute dividends and capital gains to shareholders. This is usually done at the end of each year and these distributions can be caused by index rebalancing, diversification rules, or other factors. Also, any sale (by you) of the fund may result in tax consequences. Consult your tax advisor for more specific info/advice.

How is dividend income from ETFs taxed?

ETFs, like mutual funds, are required to distribute dividends to shareholders. Dividends are taxable as income to the shareholder unless you own the ETF in a retirement account.

The Tax Relief Reconciliation Act of 2003 reduced the maximum tax rate on dividends from 35% to 15% for most investors. The rule also applies to dividend distributions paid to ETF shareholders. The dividend income from REIT ETFs may not be subject to the lower tax rate, although the capital-gains component of dividend income applies under the lower tax. Consult your tax advisor for more specific information/advice.

What are the tax advantages of ETFs?

Most ETFs are designed to track set benchmarks, which translates into fewer trades and lower portfolio turnover. This reduces the frequency of tax gain distributions. By comparison, actively managed portfolios generally have higher turnover, which can translate into untimely or more frequent tax distributions.