One of the advantages of exchange traded funds (ETFs) compared to other investment vehicles is its relative liquidity. But what is liquidity for an ETF? How does that liquidity actually give ETF investors the upper hand, compared to other assets?
In essence, ETF liquidity refers to how easy it is for investors to buy and sell. When an ETF can be bought then sold quickly for cash, it’s considered liquid.
Let’s take an extreme example. Physical real estate is pretty illiquid, compared to ETFs. To complete a real estate transaction, typically investors must follow a lengthy standardized process. First, the seller offers their property on the market. Then the buyer makes an offer. The seller accepts, an escrow is opened, financing is obtained, inspections are performed, and so on. All this must resolve before the transaction completes. This process can take months, even years.
Compare that to buying or selling an ETF. A typical retail investor can simply go to their broker, buy shares of the ETF and sell them when they wish during normal stock market hours. All of that is primarily done online these days, which adds to the speed of an ETF transaction. As long as the market is open, investors can trade ETFs. It usually takes just a few minutes.
An investor who still wants real estate exposure could also use ETFs. As opposed to actually buying real estate, which could require a hefty down payment and financing, retail investors can get the same exposure via real estate-related ETFs — and in a cheaper, more diversified package, too!
ETF Liquidity Means More Intraday Opportunities
We used an extreme example here, but the point is this: Being able to buy and sell ETFs intraday opens up intraday opportunities, which helps make ETFs a useful tool for short-term investors or day traders. But they help longer-term investors too. Buying and selling ETFs throughout the trading day allows investors to buy into positions when it’s most convenient. Compare that to mutual funds, which only trade once per day at the close of the market (4:00 PM, Eastern).
Not all ETFs can be bought and sold quickly. Volume can also play a part in how liquid an asset, particularly in the stock market, can be. After all, if there aren’t enough buyers and sellers in the market, then you probably can’t buy or sell that asset with ease.
Ideally, if someone wants to sell an asset, there needs to be demand for it, and as mentioned, the more buyers and sellers (volume), the better. This is where a market maker (potentially a broker-dealer or investment firm that buys and sells securities to maintain market efficiency), for example, can help with liquidity.
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