how etfs work
an etf must be registered with the securities and exchange commission in the united states most etfs are set up as open ended funds and are subject to the investment company act of 1940 except where subsequent rules have modified their regulatory requirements 2 open end funds do not limit the number of investors involved in the product vanguard s consumer staples etf vdc tracks the msci us investable market consumer staples 25 50 index and has a minimum investment of 1 00 the fund holds shares of all 104 companies on the index some familiar to most because they produce or sell consumer items a few of the companies held by vdc are proctor gamble costco coca cola walmart and pepsico 34 investors who buy 1 00 in vdc own 1 00 shares representing 104 companies there is no transfer of ownership because investors buy a share of the fund which owns the shares of the underlying companies unlike mutual funds etf share prices are determined throughout the day a mutual fund trades only once a day after market close volatile stock performance is curtailed in an etf because they do not involve direct ownership of securities industry etfs are also used to rotate in and out of sectors during economic cycles as of january 2024 nine etfs focus on companies engaged in gold mining excluding inverse leveraged and funds with low assets under management aum 7pros and cons of etfsaccess to many stocks across various industrieslow expense ratios and fewer broker commissionsrisk management through diversificationetfs exist that focus on targeted industriesactively managed etfs have higher feessingle industry focused etfs limit diversificationlack of liquidity hinders transactionsbuying etfsetfs trade through online brokers and traditional broker dealers many sources provide pre screened brokers in the etf industry individuals can also purchase etfs in their retirement accounts an alternative to standard brokers is a robo advisor like betterment and wealthfront an etf s expense ratio is the cost to operate and manage the fund etfs typically have low expenses because they track an index etfs are available on most online investing platforms retirement account provider sites and investing apps like robinhood most of these platforms offer commission free trading meaning that investors don t have to pay fees to the platform providers to buy or sell etfs after creating and funding a brokerage account investors can search for etfs and make their chosen buys and sells one of the best ways to narrow etf options is to utilize an etf screening tool with criteria such as trading volume expense ratio past performance holdings and commission costs order a copy of investopedia s what to do with 10 000 for more wealth building advice popular etfsbelow are examples of popular etfs on the market some etfs track an index of stocks thus creating a broad portfolio while others target specific industries etfs vs mutual funds vs stocksmost stocks etfs and mutual funds can be bought and sold without a commission funds and etfs differ from stocks because of the management fees that most of them carry though they have been trending lower for many years in general etfs tend to have lower average fees than mutual funds 8dividends and taxesthough etfs allow investors to gain as stock prices rise and fall they also benefit from companies that pay dividends dividends are a portion of earnings allocated or paid by companies to investors for holding their stock etf shareholders are entitled to a proportion of the profits such as earned interest or dividends paid and may get a residual value if the fund is liquidated an etf is more tax efficient than a mutual fund because most buying and selling occur through an exchange and the etf sponsor does not need to redeem shares each time an investor wishes to sell or issue new shares each time an investor wishes to buy redeeming shares of a fund can trigger a tax liability so listing the shares on an exchange can keep tax costs lower in the case of a mutual fund each time an investor sells their shares they sell it back to the fund and incur a tax liability that must be paid by the shareholders of the fund creation and redemptionthe supply of etf shares is regulated through creation and redemption which involves large specialized investors called authorized participants aps when an etf wants to issue additional shares the ap buys shares of the stocks from the index such as the s p 500 tracked by the fund and sells or exchanges them to the etf for new etf shares at an equal value in turn the ap sells the etf shares in the market for a profit 