There are many ways in which an ETF can deviate from its predicted index. This tracking error can be a cost to investors. Indices don't hold cash, but ETFs do, so you expect a certain amount of tracking errors in an ETF. Fund managers generally keep some cash in a fund to pay administrative expenses and management fees.
Yes, liquidity is an important consideration when investing in exchange-traded funds (ETFs). ETFs have different liquidity profiles for several reasons. Investing in an ETF with relatively low liquidity can cost you in terms of a wider spread between buy and ask, fewer opportunities to trade profitably and, in extreme cases, the inability to withdraw funds in certain situations, such as a big market crash. However, there are disadvantages to ETFs.
They come with commissions, can deviate from the value of your underlying asset, and (like any investment) carry risks. Therefore, it is important for any investor to understand the disadvantages of ETFs. This problem, along with others, can create tracking errors or the difference between the performance of an investment portfolio and the performance of a chosen benchmark. That means that an ETF could end up costing more than the underlying assets, and an investor could pay a premium when buying that ETF.
Fortunately, this is rare and is usually corrected over time. ETFs make a lot of sense in the right situation. However, there are also several very good reasons not to use them. Your individual situation, your values, your goals and objectives will determine if and when they make sense to you.
Think of ETFs as deposits that contain a collection of securities, such as stocks and bonds. Because ETFs are made up of these multiple assets, they provide investors with instant diversification. When an investor buys a share of an ETF, their money is divided between different investments. This differs from stocks where you buy shares in a single company.
Passive captures 100% of every market crash Undoubtedly, the best way to create a good investment strategy is to use index options for the few asset classes that are extensively hedged and researched and actively managed for all other asset classes where they still exist inefficiencies. It is clear that liabilities outperform in large-cap asset classes, but in almost all other investment categories, active management seems to be the best option. Since ETFs come as a package of diversified holdings rather than a single share, there is less day-to-day volatility. Depending on your objectives, that may or may not help your strategic perspective.
Low volatility means your capital won't rise 20% on any given day, but it won't fall 20% either.
