Three myths about ETFs debunked

01 March 2020 by National Bank Investments
NBI Monthly

Over the last decade, exchange-traded funds (ETFs) have garnered popularity among investors. Below are three of the most misguided myths surrounding ETFs, still to this day.

ETFs are exactly like individual stocks.

ETFs and stocks may seem to be similar. They both trade on an exchange, where investors can buy and sell during open trading hours. The reality is that they differ in two key areas.

Whereas individual stock prices are driven by market supply and demand between investors, ETF trading prices are based on the value of the underlying securities held within their basket.

An example of this is when there are more investors wanting to buy a stock versus selling it, as the market price of the stock tends to rise. ETF prices are dependent on the market maker’s calculation of its net asset value; which determines the fair bid and ask price for the ETF.

The second key difference between stocks and ETFs is liquidity. Stocks have a set number of shares outstanding and their liquidity often reflects how easily their shares can be bought and sold without drastically affecting their price.

ETF liquidity is essentially dependent on the liquidity of its underlying securities and facilitated by market makers through their process of creation and redemption of units. This is one of the most unique characteristics of ETFs.

ETFs are only good for passive broad market exposure.

While it’s true that some of the very first ETFs where investments created to track a specific index or benchmark; many innovations have since evolved in the space allowing investors a much wider scope of ETF choices.

Many of these come on the form of actively managed ETFs. Much like an actively managed mutual fund, a portfolio manager or team is behind an active ETF providing the value-added investment decisions and construction.

Many of these actively managed ETFs have branched out into niche investment themes ranging from infrastructure investing to private equity and other liquid alternatives that don’t necessarily track a specific index.

ETFs are only good for short‑term investors

While it is true that many active traders use ETFs for short-term market exposure, they can also be used as buy-and-hold investments for longer term investors.

The product design of ETFs allows for different investors with different investment objectives to hold the same ETF while accomplishing their respective goals.

It is normal that many investors continue to have questions surrounding ETFs. As with any investment it is always important to do your own research and understand what you are investing in. ETFs continue to be another tool within an investor’s arsenal helping to achieve their financial goals.

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