But the way ETFs are priced, and bought and sold, differs from mutual funds. A mutual fund may be purchased or sold only at a price based on the net asset value (NAV) of the fund, which is typically determined once a day and is based on the closing price of all the securities in the portfolio at the end of the trading day. By contrast, you can buy and sell ETFs, like stocks listed on a stock exchange, throughout the trading day. When you want to buy or sell shares of an ETF, you'll see a bid and ask price for the shares, just like an individual stock. As with stocks, the price at which an ETF trades varies throughout the day.
With ETFs that trade frequently and track very liquid underlying securities, like the large-capitalization stocks in the S&P 500 Index, the price of the ETF and value of the securities in the fund tend to track closely. However, the price of an ETF that holds less liquid securities - like certain types of fixed income securities or stocks traded on a small foreign market that is closed during US trading hours - could vary more significantly from the NAV of the securities in the ETF. Also, most ETFs are passively managed (i.e., they attempt to track a benchmark index), while some are actively managed (i.e., they try to outperform a benchmark index).
In next blogpost, we will discuss the pros of ETF and some caveats.