An exchange traded fund is similar to a mutual fund in a lot of different ways. An ETF is a collection of different stocks and bonds, all grouped together so that you are investing in all of them simultaneously. This means that you’re spreading out your investment and thus you have a much better chance of increasing your initial investment and getting a return. Think of it like a roulette wheel where you bet on a spread of numbers instead of on a single number, but you could theoretically win with all the numbers on a single spin. Of course for every good investment you have to look at all of the variables, and one of the important variables with ETF trading is how much of a liquidity risk it is.
While an exchange traded fund has the capacity to make you a lot of money, you have to ask how quickly you can turn your investment back into cash when you need it. This financial alchemy is called liquidity, and it can be very important if you need cash and you need it quickly. After all making money is a great thing, but an investment that has a narrow window where you can get the money you’ve made, or an investment that says you have to wait a certain number of years before you can withdraw money, is something of a liquidity risk. On the other hand if you can show up any day of the week while the market is still open and request a transfer of your investment into cash, then your ETF has a very high liquidity, allowing you access to your money whenever you need to have it.
If you decide that an exchange traded fund is the investment for you then you need to look at just how strong the grip it has on your initial investment and any earnings that you make from it is. After all, even if you don’t have any pressing financial needs when you first make the investment, situations can change and you might need to liquefy your assets so that you can make necessary payments on health costs, home investments or other sorts of sudden costs that can leap up at you from nowhere in life. And if you don’t have the option of taking money from your ETF investment then for all intents and purposes, that money isn’t there.