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Buying & selling ETFs

Learn how trading ETFs is similar to trading stocks.

POINTS TO KNOW

  • ETFs are actively traded during the day like stocks.
  • You must have a Vanguard Brokerage Account to purchase Vanguard ETFs® and ETFs from other companies.
  • There is no commission to buy Vanguard ETFs in a Vanguard Brokerage Account.

How to buy ETFs

ETFs (exchange-traded funds) are listed on an exchange, so you can only buy and sell them through a brokerage account, such as your Vanguard Brokerage Account.

Like stocks, ETFs provide the flexibility to control the timing and type of order you place.

Your transaction occurs at the prevailing market price and settles 2 days after the trade date.

How ETFs are priced

Because ETFs trade like stocks, their share price fluctuates throughout the day, depending on supply and demand.

This natural market fluctuation means ETF shares can be traded at either a premium or a discount relative to their net asset value (NAV).

What's the minimum purchase?

You can buy an ETF for as little as the cost of 1 share—giving you the opportunity to start investing with less money.

Expense ratio

Every ETF has an expense ratio, which covers the cost of operating the fund. The average Vanguard ETF® expense ratio is 77% less than the industry average.*

Bid-ask spread

The bid-ask spread in an ETF quote is typically a few pennies per share.

Commissions & fees

There are no commissions to buy or sell Vanguard ETFs through your Vanguard Brokerage Account. Other brokers may charge commissions.


WATCH AND LEARN

Take a closer look. One of our experts explains how ETFs are different from mutual funds, the costs associated with ETF investing, and how ETFs are priced and taxed.


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REFERENCE CONTENT

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ETF (exchange-traded fund)

A type of investment with characteristics of both mutual funds and individual stocks. ETFs are professionally managed and typically diversified, like mutual funds, but they can be bought and sold at any point during the day using straightforward or sophisticated strategies.

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Exchange

A marketplace in which investments are traded. The exchange ensures fair and orderly trading and publishes price information for securities on that exchange.

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Stock

An investment that represents part ownership in a corporation. Each share of stock is a proportional stake in the corporation's assets and profits.

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Settlement date

The date by which a broker must receive either cash or securities to satisfy the terms of a security transaction.

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Trade date

The actual date on which shares are purchased or sold.

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Marketable limit order

A limit order to buy or sell a security whose price limit is set either at or above the best offer when buying or at or below the best bid when selling. This essentially accomplishes the same goal as a market order, but with some price protection.

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Market order

An order to buy or sell a security at the best available price. Immediate execution is likely if the security is actively traded and market conditions permit. Execution price is not guaranteed and can vary during volatile markets.

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Share

A single unit of ownership in a mutual fund or an ETF (exchange-traded fund) or, for stocks, a corporation.

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Premium & discount

When an ETF trades at a price that's higher than its net asset value (NAV), it's said to be at a premium. When an ETF trades at a price that's lower than its NAV, it's said to be at a discount.

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Net asset value (NAV)

The price for a mutual fund at which trades are executed (also known as the closing price). It's calculated at the end of each business day.

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Expense ratio

The annual operating expenses of a mutual fund or ETF (exchange-traded fund), expressed as a percentage of the fund's average net assets. It's calculated annually and removed from the fund's earnings before they're distributed to investors, directly reducing investors' returns. For example, if you had $10,000 invested in a fund with an expense ratio of 0.20%, you'd pay about $20 a year out of your investment returns.

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Bid-ask spread

Bid: The price that someone is willing to pay for a particular security.

Ask/Offer: The price at which someone is willing to sell a particular security.

The bid/ask spread refers to the difference between the highest buyer's price (best bid) and the lowest seller's price (best ask).

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Mutual fund

A type of investment that pools shareholder money and invests it in a variety of securities. Each investor owns shares of the fund and can buy or sell these shares at any time. Mutual funds are typically more diversified, low-cost, and convenient than investing in individual securities, and they're professionally managed.

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ETFs 101

What is an ETF?

Liz Tammaro: So we received quite a few questions in advance when you all registered for this webcast. We're going to get started with our first question and, Jim, I'm going to give this one to you. So it makes a lot of sense before we get started, let's define what is an ETF.

Jim Rowley: Simply put, an ETF is an exchange-traded fund, right? It's a pooled investment vehicle that acquires or disposes of securities. Investors own a pro rata share of the assets in that fund. The fund issues new shares or redeems existing shares to meet investor demand.

Furthermore, and I should say providing some type of an investment exposure to those advisors, whether it's an index in particular or a market strategy. And when you think about even more so what makes them similar to mutual funds is that the majority of ETFs are organized and regulated as investment companies under the Investment Company Act of 1940. And that's the same regulatory regime under which mutual funds operate. So for all the discussions sometimes we hear about differences between mutual funds and ETFs, they're overwhelmingly similar actually.

Liz Tammaro: And even thinking about that, we can talk about maybe what are some of the benefits of the mutual fund versus an ETF or, sorry, even vice versa, ETF versus mutual fund. And even maybe what are some of the disadvantages.

Jim Rowley: I'll take that because I think I don't necessarily like the word disadvantage. I think differences is maybe the more appropriate term. And we just addressed some of the similarities between ETFs and mutual funds, so it's maybe more important to know what are the actual differences. And really the differences come down to two major items and they both relate to how investors transact in shares of those funds, right? We're talking about exchange-traded funds.

ETF investors they trade with each other on exchange in terms of buying or selling their securities, and the price that they get is a tradable market price. Mutual fund investors, on the other hand, they are buying and selling their shares directly with the fund and they might do that through some type of intermediary but it's back and forth with the fund itself and they get an end-of-day NAV.

So we think about all the similarities and, again, sometimes there's a discussion about how different they are; but, really, the differences come down to those two items. It's trading on exchange versus direct with the fund and it's trading at a market price rather than getting the end-of-day NAV.

Jim Rowley: I think we actually have a great way to illustrate that. I think we have a chart that addresses that point that Doug was talking about that ETFs are overwhelming. They just happen to be index funds. And when the chart comes up, a simple way to illustrate this is we look at expense ratios. But instead of breaking them down by ETF versus mutual fund, we break them down by index fund versus nonindex fund separated into ETF and mutual fund. And when you see the expense ratios, you see that given an indexing strategy, whether it's a mutual fund or an ETF, the expense ratios tend to be lower than they are for the nonindex strategies, whether it's an ETF or a mutual fund.

So it has a lot more to do with whether or not it's an indexing strategy than whether or not it's an ETF or a mutual fund.

Liz Tammaro: And similar to that question, we have another one that's come in from Bruce asking about how easy is it to buy and/or sell an ETF versus a mutual fund?

Jim Rowley: A lot of moving parts in that question because I think the default has always been mutual funds because they've been around longer. So it becomes a lot of a comfort decision in many ways where purchasing a mutual fund is usually done in dollars. You put your orders in in dollar terms. You're happy to hit the enter button on your keyboard because you know at the end of the day your order is going to execute at the end of the day with a 4 PM NAV. You might be able to get fractional shares because your order gets rounded up into dollars and the mutual fund takes care of the automatic reinvestment for you.

With an ETF, investors need to be aware of transacting through their brokerage account. And now the dynamic might be a little bit different because you have to put your order in in shares, mutually speaking. There's no fractionals there. When you put your order in shares, you get a corresponding dollar amount rather than put the order in dollars and you get a corresponding share amount.

So, you know, the ease comes with a comfort level that a particular individual might choose or have a preference for doing.

ETF costs vs. mutual fund costs

Liz Tammaro: Another live question has come in. This one from Terrence asking, "So let's say I have narrowed down my choice to one index class," I think one asset class is what we're saying here, "How do I determine and compare ETF transaction costs versus mutual fund transaction costs?"

Jim Rowley: I was going to say, one maybe the audience would find interesting and we had the question earlier about do ETFs have expense ratios? And the answer is yes. And when we think about transaction costs and expense ratios remembering the funds, an ETF or a mutual fund, it's their expense ratio that they own, to use a certain phrase, but sometimes the transaction costs are not the funds necessarily.

Brokerage commissions or some mutual funds might have sales charges if they're purchased elsewhere. So if you buy a Vanguard ETF through Vanguard brokerage and you might not face a brokerage commission doing it there, but for some other investors who want to acquire a Vanguard ETF at somebody else's investment platform, they might face the brokerage commission there.

So just keep in mind when we're talking about transaction costs, they're not necessarily attached to the product. They're part of that brokerage platform or investment provider's transaction cost set up there. So they're not always attached to the fund.

Liz Tammaro: Now I actually have another question that was presubmitted still on this topic of cost. I think it's similar, but a little bit different. "So can you please discuss the relative cost over time of a fund versus an ETF?" I hear you talking about transaction cost and that seems like part of the initial cost, but how about this idea of cost over time?

Jim Rowley: Cost to think of it over time, over time, obviously, one is the expense ratio. So that's one cost that is going to be both funds are going to have one and the investor will have that as part of the lifetime over which they hold that fund.

I think some would consider taxes to be a cost so to the extent that a fund has any capital gains distributions. And at least for ETFs that are 40 Act funds, right, I referenced before the overwhelming majority of ETF assets they're as 40 Act funds, they're subject to the same rules under the Internal Revenue Code as mutual funds. So to investors, their taxation experience is the same.

For example, if an investor who holds a 40 Act ETF when they buy and sell their shares to the extent they trigger any capital gains, if they buy and sell their shares of the ETF, they trigger capital gains and they would be subject to similar taxation. If there is portfolio activity within the ETF or within the mutual fund, and, again, when we're talking about 40 Act funds, if there are any capital gains triggered by the portfolio, long term or short term, the investor is taxed at those appropriate long term or ordinary income rates. And then the third part being if the ETF, that's a 40 Act fund or a mutual fund, if it pays any dividends, investors are taxed at that relevant rate the way they would be the mutual funds.

So I use that as going back to the similarities, but, again, from the cost perspective, if expense ratio is one, taxes come up all the time as another one; and I think they're worth heeding.

Liz Tammaro: Good. We're getting so many great questions that are coming in. Now we have one that has come from Twitter. This person is asking or has tweeted, I should say, "I am not a day trader. Could ETFs be right for me?"

Jim Rowley: Yeah, I'd love to take that, actually, because I think on the green widget resource bar, there's a blog that I had written about a conversation I had explaining ETFs to my dad.

Liz Tammaro: Sure.

Jim Rowley: And, you know, it was written off of a conversation I had with my dad; and he said, you know, he calls me Jimmy. Right, he says, "Oh, Jimmy, I'm not a day trader, so I don't need ETFs." And I said, "Well, you know, dad," much like we've talked about here, "you can get ETFs that are broadly diversified index funds that come with low expense ratios. And just because you can day trade it doesn't mean you have to day trade it. They are absolutely very well suitable as long-term strategic products in your portfolio.

ETF pricing and tax structure

Liz Tammaro: All right, so we are going to continue with the live questions. Dean is asking, "I'm still confused about the spread, the bid-ask concept. Which one do I pay when I purchase, which one do I sell at, and how does this create cost?" So let's take a moment and just focus in on this bid-ask spread concept.

Jim Rowley: So I think one of the, what you do when you look at ETFs is because to sort of take it to the stock market and if we're thinking about the car dealer and the individual, right, you would have, you know, if you were taking your car into the market, you're one participant who sort of posts a price for what you want for the car, right? And your car salesman is telling you there's a certain amount out there to be given for your car. So, I forget the numbers used. If your car was at $5,000, let's say, that becomes the offer price out in the marketplace for that car. But if somebody's only offering for him, his car, $4,900 or 800, that's the bid price on the market. So you have a $5,000 offer out in the market and a $4,900 bid, right, that's the ask price versus the bid price; and the $100 difference would be the spread that you would simplify the two.

Liz Tammaro: And a question from Ann, submitted to us from Colorado. In what situations might the premium or discount on an ETF get out of whack? Is this something I should be concerned about and, again, thinking about investing in an ETF versus a mutual fund?

Jim Rowley: One of the main causes that you might see a premium or discount is actually because of one of the features of ETFs. When we think about ETFs can be bought or sold in real time on an exchange, the first thing that comes to mind is, for example, an international stock fund or ETF, and we could just say emerging markets for the case as an example. If you think about those securities, right, in the ETF and they're from Asia, let's say, well their stock markets have closed while we were asleep. We haven't even gotten up and started our day. So those stocks have been, those exchanges are closed. Those prices have been marked, so to speak, but the international stock ETF is trading here in the US. And it's trading based upon news and information that's going on right now.

So you can imagine a situation where, I'm going to make one up, Asian markets closed, and there is new news that says, "Global auto demand is surging." Well, as those Asian markets are closed, those US investors here are saying, "Wow, if those underlying markets were open, those stocks would be probably rising today." And the opposed were true, right, if there was news that demand for computers fell, that would be bad news for the market.

So what happens is the ETF is being priced by market participants who are saying, "What would those underlying securities be if those markets were still open?" So you could end up your day where there's a premium or a discount because the news cycle, it's closed in those overseas markets, but it's running real time here and now.

Liz Tammaro: Good, thank you for clearing that up. I think that that's helpful. One of our presubmitted questions is about taxes. We started to talk a little bit about taxation, Jim. We have Brenda who is asking, "Are there differences in the taxes paid on ETFs versus mutual funds?"

Jim Rowley: Yeah, happy to talk about this because there's actually urban legends sometimes we hear. "Oh, ETFs, they don't pay capital gains."I mean they can and they do. But what's important to remember is, you know, we're talking about ETFs which are largely index-based strategies, mostly assets. So indexing in and of itself is a very tax-efficient strategy.

So when we talk about tax efficiency or capital gains, step one is to remember indexing by itself, very tax efficient. So when we see these benefits of, "Oh, ETFs are tax efficient," remember, that kind of comes from indexing first and ETFs are weighted to carry that through. But maybe then to resummarize again is for those ETFs that are 40 Act funds, like we talked about, meaning they're subject to the same regulatory environment as mutual funds, you know, whether or not you as the investor generate capital gains because you're the one buying and selling the shares, right, number one. Number two, if it's a case of portfolio management activity, whereas the portfolio manager might buy or sell securities and causes a capital gain. Or sort of number three, the portfolio, the fund generates a dividend and pays it out. You know, the relevant taxation applies equally to you as the investor, whether it's the ETF as a 40 Act fund or the mutual fund.


Important information

All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss.

For more information about Vanguard funds or Vanguard ETFs, visit vanguard.com, or call 877-662-7447, to obtain a prospectus. Investment objectives, risks, charges, expenses, or other important information are contained in the prospectus; read and consider it carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.

Advisory services are provided by Vanguard Advisers, Inc. (VAI), a registered investment advisor.

© 2015 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor.