Investing Basics

A quick Q&A on ETFs

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If you're like many investors, you’re probably somewhat familiar with ETFs. You may even own ETF shares in one of your brokerage or retirement accounts. But that doesn’t mean you don’t still have questions about ETF investing basics, and how much of a role they could play in your long-term investment planning and your portfolio. The following are a few of the most common questions investors ask us about.

Why is the market price sometimes different from the net asset value (NAV) of an ETF?

The NAV of an ETF is an accounting value assigned to each share of the fund. It’s calculated by adding up the value of all assets in the fund, subtracting any liabilities, and then dividing that amount by the total number of shares outstanding.

An ETF’s market price is simply the price at which shares can be bought or sold during trading hours. It’s a reflection of the highest price at which buyers are willing to purchase shares and the lowest price at which sellers are willing to sell them.

For most ETFs (especially those like the Invesco QQQ ETF which is actively traded 1), those two values are nearly identical. Occasionally, though, there may be small differences between the market closing price for an ETF and its NAV. This is usually the result of a supply and demand imbalance where there’s a spread in price between what sellers demand and what buyers are willing to pay. Again, this is most often seen in ETFs that trade a lower daily volume of shares.

What types of ETF trades can be placed?

Since, like stocks, ETFs trade on a secondary market, you can place all the same types of trade orders you might use for stock trading. These include:

  • Market orders—an order to immediately buy or sell at the current price
  • Limit orders—an order to buy or sell at some point in the future when a target price is reached
  • Stop loss orders—an order to sell that remains dormant until a certain price is reached, at which point the order then activates and becomes a market order
  • Stop limit orders—similar to a stop loss order, but instead of activating as a market order, a stop limit order activates as a limit order that will only execute at the limit price or higher
  • Good ‘til cancelled—an order that remains active until such time as you cancel it; most brokerage firms limit the amount of time it can be kept open to 90 days
How is the market price of an ETF determined?

As discussed above, an ETF’s market price is the price at which you’re able to buy or sell shares on an exchange. Generally, the market price is expressed as two separate prices: a ‘bid price’ which is the price buyers are willing to pay; and an ‘ask price’ which represents the price that sellers are willing to accept for their shares. While closely linked to the NAV, the market price can be impacted not only by supply and demand, but by global events that occur before or after the U.S. exchanges are open for business.

Are ETFs appropriate for individual investors?

In many cases, the answer to this ETF investment question is a resounding yes. For individual investors who are seeking a well-diversified portfolio for the long term, ETFs that track major indexes may provide an easy way to obtain broad investment diversification through a single holding. They typically entail far less cost and expense compared to having to purchase shares of multiple stocks. And in some cases, they are more affordable and tax-efficient than their mutual fund brethren.

Footnotes

  • [1] Source: Bloomberg L.P., 2nd most traded ETF in the US based on average daily volume traded, as of June 30, 2021.

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