Some investors gloss over the "exchange-traded" in "exchange-traded fund," failing to understand or appreciate those two words and the implications of investing in a fund that trades like a stock. The exchange-traded nature of these funds is increasingly taken for granted, as many of the largest ETFs trade at tight spreads in very narrow bands around their net asset values through most market conditions. But not all ETFs are created equal from a liquidity perspective, and investors shouldn't take ETFs' liquidity for granted. In addition, the market mechanisms that underpin the ETF ecosystem have experienced hiccups of varying magnitude, ranging from the "flash crash" in 2010 and the early-morning meltdown witnessed on Aug. 24, 2015, to more sporadic episodes of lesser scope and impact. These events have served as painful reminders of why investors should exercise caution when buying and selling ETF shares.
With market volatility back on the rise, now is a good time to brush up on what constitutes good hygiene when transacting ETFs. Here, I provide five tips on how to best trade them.
Ben Johnson, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.