Anatomy of an Exchange-Traded Fund: Buying and Selling

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Anatomy of an Exchange-Traded Fund: Buying and Selling

The process of buying and selling exchange-traded funds (ETFs) works differently than with mutual funds. In terms of trading, ETFs have more in common with individual stocks than with mutual funds. You can purchase ETFs in real time at any point during the trading day, unlike mutual funds which settle only once a day. This means you can use trading features like stop-losses, limit orders or margin trades on an ETF that you can’t use on an open-end mutual fund. You can even sell ETFs short, or trade options on an ETF! Also, there are no redemption fees on ETFs, unlike on many of their mutual-fund cousins, but investors do pay a transaction fee to their broker every time they buy or sell ETF shares.

NAV and share price

Because ETFs trade on an exchange, every transaction involves a third party, unlike mutual funds where you buy and sell the shares with the fund company. This means that ETFs will have both a net asset value (based on its portfolio holdings minus accrued expenses, just like a mutual fund) and a share price (based on the supply and demand for the ETF shares, just like a stock).

Other factors that change the prices

While the supply and demand for ETF shares (and hence their market price) is largely driven by the underlying values of their portfolios, other factors can occasionally cause them to trade at a premium or discount to that value. When this happens, authorized participants swoop in to create or redeem shares of the ETF in exchange for the basket of underlying securities, which helps close the spread between the ETF market price and its net asset value.