Yes, ETFs are redeemable, but probably not by you. Under federal securities law the shares are redeemable securities, and that legal status is what lets a fund call itself an ETF in the first place. In practice, though, only a small group of large financial firms called authorized participants can hand shares back to the fund in exchange for the securities inside it. Individual investors exit a different way: by selling their shares to another buyer on a stock exchange, at the market price, through an ordinary brokerage account.
That split between institutional redemption and retail selling is the whole story. Once you understand it, the rest of how ETFs work falls into place.
How You Actually Sell Your ETF Shares
If you own 100 shares of an ETF, you cannot send those shares back to the fund company and receive the underlying stocks in return. You don’t have the required agreement with the fund, and 100 shares is nowhere near the minimum size the fund will accept. Your exit is the secondary market.
You place a sell order through your brokerage, the trade executes during market hours at the current market price, and the cash arrives in your account one business day later under the T+1 settlement standard, which took effect on May 28, 2024.1U.S. Securities and Exchange Commission. Frequently Asked Questions Regarding the Transition to a T+1 Standard Settlement Cycle Most major brokerages charge nothing for online ETF trades. Representative-assisted trades still carry fees; Fidelity charges $12.95 by phone, for example.
The price you receive on the exchange closely tracks the fund’s net asset value, because authorized participants are constantly arbitraging away any meaningful gap between the two. You’re not giving anything up by selling on the open market instead of redeeming directly. You’re getting essentially the same value, immediately, without needing millions of dollars in capital or a signed agreement with the fund sponsor.
Who Can Redeem Directly With the Fund
An authorized participant is a firm, usually a large bank or market maker, that has signed a written agreement with the ETF or one of its service providers allowing it to place orders for the purchase and redemption of creation units.2eCFR. 17 CFR 270.6c-11 – Exchange-Traded Funds The firm must also be a member of a registered clearing agency, meaning it has the infrastructure to settle large securities transactions. No other type of entity can walk up to a fund sponsor and swap shares for the portfolio inside.
Any given ETF usually has fewer than a dozen authorized participants. They don’t trade individual shares. They trade in creation units, which are large blocks typically ranging from 25,000 to 100,000 shares.3ProShares. Understanding ETF Liquidity and Trading At a $50 share price, even the smaller end represents $1.25 million in value. The exact creation unit size is set in each fund’s prospectus. These thresholds exist because every redemption triggers real operational work, and allowing small transactions would bury the fund in administrative costs.
What an In-Kind Redemption Looks Like
When an authorized participant redeems, the standard process doesn’t involve cash. The participant gathers enough ETF shares to form a creation unit and delivers them to the fund. In return, the fund hands back a basket of the actual securities it holds, whether stocks, bonds, or whatever makes up the portfolio.4Schwab Asset Management. Understanding the ETF Creation and Redemption Mechanism The participant walks away with securities, not dollars. The fund never sells anything on the open market; it simply transfers ownership of positions it already holds.
Some funds do allow cash redemptions, particularly bond ETFs and commodity funds where delivering the actual underlying assets would be impractical. In those cases the fund itself has to sell securities to raise the cash, and the authorized participant typically pays a transaction fee to offset that cost.4Schwab Asset Management. Understanding the ETF Creation and Redemption Mechanism Cash redemptions are less tax-efficient, which is why in-kind remains the default for most equity ETFs.
Why the Two-Track System Benefits You
The reason this structure matters to ordinary shareholders is tax. Section 852(b)(6) of the Internal Revenue Code says that when a regulated investment company distributes property, rather than cash, to redeem a shareholder’s stock, the fund doesn’t recognize any gain on the securities it hands over.5Office of the Law Revision Counsel. 26 U.S. Code 852 – Taxation of Regulated Investment Companies In plain terms, the fund can send out stocks sitting on huge unrealized gains and never owe tax on those gains. Those built-up gains leave the fund permanently with the authorized participant.
You benefit from that even though you have nothing to do with it. Because gains leave the fund in-kind rather than being realized through open-market sales, the fund has far less to distribute to shareholders at year-end. In 2025, only 7% of ETFs distributed capital gains to shareholders, compared to 52% of mutual funds. Among equity funds specifically, 6% of ETFs paid out a capital gain versus 57% of equity mutual funds.6State Street Global Advisors. Tax Efficiency Is Structural: ETFs Continue to Issue Fewer Capital Gains Than Mutual Funds That gap isn’t about better stock picking; it’s structural.
The same mechanism keeps the market price close to the value of the fund’s holdings. When an ETF drifts to a discount, an authorized participant can buy the cheaper ETF shares on the exchange, redeem them for the more valuable underlying securities, and profit on the difference.7Schwab Asset Management. Fixed Income ETFs: Understanding Premiums and Discounts That shrinks share supply and pushes the price back up. The reverse happens at a premium. The arbitrage only runs when the gap is wide enough to cover transaction costs, so for highly liquid equity ETFs the spread between price and value stays very thin. For bond ETFs or funds holding illiquid securities, premiums and discounts can persist longer because the underlying assets are harder to price and trade in real time.
When Selling or Redemption Can Be Blocked
Federal law puts tight limits on how long a fund can delay paying a redemption. Under the Investment Company Act, a registered investment company must satisfy a redemption request within seven days of receiving it.8Office of the Law Revision Counsel. 15 U.S. Code 80a-22 – Distribution, Redemption, and Repurchase of Securities The fund can suspend that obligation only in narrow circumstances:
- The New York Stock Exchange is closed for reasons other than normal weekends and holidays.
- Trading on the NYSE is formally restricted.
- The fund cannot reasonably sell its securities or cannot fairly determine the value of its net assets.
- The SEC specifically permits a suspension to protect shareholders.
Separately, the SEC can suspend trading in any individual stock or ETF for up to 10 trading days when it determines a suspension is necessary to protect investors and the public interest.9U.S. Securities and Exchange Commission. Trading Suspensions During a trading suspension you can’t buy or sell the ETF on an exchange at all, which effectively freezes both institutional redemptions and retail sales. These suspensions are rare and typically involve concerns about the accuracy of public information about the fund or its holdings.
What Happens If the ETF Liquidates
An ETF can close permanently. When a sponsor decides to liquidate a fund, usually because assets have dropped too low to justify operating costs, the process looks nothing like normal redemption. The fund announces a liquidation date, typically with at least 30 days’ notice. Trading continues on the exchange until a final delisting date, after which any remaining shareholders receive a cash payout based on the fund’s net asset value.
This is where ETF tax efficiency breaks down. A liquidation is a taxable event. You’ll realize a capital gain or loss based on the difference between your cost basis and the liquidation proceeds, whether you wanted to sell or not. The in-kind mechanism that normally shields shareholders doesn’t apply, because the fund is selling everything for cash and distributing the proceeds.
If you receive notice that an ETF you hold is liquidating, selling before the final date gives you more control. You can choose your exit point, manage the tax consequences around other gains and losses for the year, and avoid the wait for the final cash distribution. Holding through liquidation isn’t catastrophic; you’ll get fair value. It just takes away your ability to choose when the taxable event hits.