Because exchange traded funds are bought and sold like individual stocks, they raise issues that traditional mutual fund investors don’t have to worry about.
For example, ETFs have so-called bid/ask spreads that are based on the liquidity of underlying securities. The ETF’s trading volume can also impact bid/ask spreads. [What are ETFs?]
Mutual funds are priced once a day at the close, but ETFs can be traded throughout the day. [What is an ETF? Premiums and Discounts]
Selena Maranjian for The Motley Fool notes that ETFs tracking the more illiquid asset classes have wider spreads. Examples include obscure emerging markets and high-yield bonds.
Meanwhile, ETFs tracking liquid baskets such as SPDR Dow Jones Industrial Average (NYSEArca: DIA) have extremely low spreads, according to the report. It should be noted that low trading volume doesn’t necessarily mean an ETF has wide bid/ask spreads. Investors also need to consider the liquidity of the market the ETF tracks.
“Another way to protect yourself is to use limit orders when you trade ETFs, so that you’re not surprised by an execution price much worse than you expected,” Maranjian writes.
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.