Seven Huge Mistakes Every ETF Investor Needs To Avoid

The ETF world has grown by an incredible amount over the last few years. There are close to 1,750 products in the market while assets under management has cleared $2 trillion in the U.S.

But while ETFs have grown immensely in popularity, it is still amazing to hear how many misconceptions I hear or read about the product category. Many investors, and even professional ones, don’t seem to get many of the ETF basics despite the growing importance and use of these funds in portfolios.

In light of this, I’ve taken a look at seven common misconceptions or errors that I frequently hear or see regarding ETFs. Hopefully after reading the list below you will know a bit more about how to use ETFs in your portfolio, and will be able to avoid some of the key pitfalls that tend to trip up novice ETF investors:

 ‘That’s a low volume ETF, I can’t buy that!’

Many investors think about ETFs just like they think about stocks. And for the most part this is a fine strategy, it can get you into trouble when it comes to volume. Most investors might see ‘low’ volumes for some ETFs—below 50,000 shares a day—and think that they will either move the market, or simply won’t be able to get in at a good price.

While this sometimes will be the case, it usually isn’t true for ETFs. Exchange Traded-Funds derive their liquidity from their underlying holdings so if you are investing in an ETF that has large cap U.S. stocks, it should be easy to trade it reasonably without worrying about volume (also see The Truth About Low Volume ETFs).

After all, if prices deviate too far from the underlying holdings’ trading value, market makers can step in with arbitrage to correct any imbalances. It is probably more useful to be mindful of bid/ask spreads when trading ETFs and so-called level two quotes to get a better idea of tradeability. Usually, on many low volume ETFs you’ll see tight bid ask spreads meaning it should be pretty easy for you to get in and out of a fund.  

‘Just pick any ETF that has the theme I am looking for’

(IBB – ETF report) and (XBI – ETF report) both track the biotechnology market, though they do so in very different ways. IBB tracks a mostly large cap-focused index while XBI has an equal weight approach which gets more small cap biotech names in there. While this might seem like a relatively minor detail—both still follow biotechnology after all—it can result in a huge performance differential.