ETFs March 18, 2015

    Exchange-traded funds (ETFs) are funds that own some collection of assets—securities, bonds, stocks, commodities, etc. ETFs generally track an index, giving investors broad exposure to a particular asset class, industry or region. Rather than selecting and buying multiple individual securities, investors can use ETFs to more easily invest in a specific part of the market, achieve diversification or fill gaps in their portfolio.

    Similar, but not the same

    ETFs are similar to index mutual funds, but there are key differences. For example, you can only buy a mutual fund at the end of the day, at its closing price or net asset value (NAV). ETFs, on the other hand, trade on an exchange like stocks, so you can buy and sell shares at any time during the trading day at market price. This means that you can buy an ETF at its current intraday price.

    ETFs are growing faster than mutual funds

    While there are about six times more mutual funds than ETFs available in the market, ETFs have grown quickly in popularity. Over the last 10 years, ETF assets have grown from $228 billion to $1.8 trillion.1 Although the $13.1 trillion in total assets managed by equity, bond and hybrid mutual funds is significantly larger than that, ETFs' percentage of the two industries' combined assets has increased over that same time period, from less than 3% at the end of 2003 to more than 12% by June 2014.1

    Transparent, tax-efficient and low-cost

    Most ETFs are considered "passively managed" because they typically aim to track an index rather than outperform it. This means ETFs generally make trades only when they buy or sell an investment to stay on track with their target index. Because they typically place fewer trades than actively managed investments, ETFs tend to have lower management costs. Also, because ETFs generally make capital gains distributions less frequently, they tend to be more tax-efficient than mutual funds, which usually make these distributions annually. ETFs typically defer such distributions by shedding their lowest-basis shares to institutional traders. And finally, ETFs may also make sense for investors interested in transparency. The SEC requires ETFs to publish the details of every security in the fund daily, but only requires mutual funds to report their underlying securities quarterly.

    The preferred vehicle for automated investing

    Schwab Intelligent Portfolios™ uses ETFs for all these reasons, but mainly because they provide a convenient vehicle for diverse investments at a low cost. The diversification ETFs provide can help your portfolio weather volatility, and their comparatively low cost reduces the potential for fees to erode your long-term returns.

    1. Source: Investment Company Institute.

    Investment returns will fluctuate and are subject to market volatility, so that shares, when redeemed or sold, may be worth more or less than their original cost. Unlike mutual funds, ETF shares are bought and sold at market price, which may be higher or lower than the net asset value (NAV). All ETFs are subject to management fees and expenses.

    Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

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