When investors choose an ETF, they often look at expense ratios, holdings, or past performance. But one factor is frequently overlooked: liquidity.
In simple terms, liquidity determines how easily and cheaply you can buy or sell shares of an ETF. While this may sound like a technical detail, it can have a huge impact on your long-term returns and the flexibility of your investment strategy.
Liquidity becomes especially important when markets are volatile, when trading larger amounts, or when investing in niche ETFs. Many investors underestimate this factor and end up paying hidden costs that quietly reduce their gains.
This article explains what ETF liquidity is, how it works, and why it matters more than you might think—whether you’re a beginner or a seasoned global investor.
Contents
What Is ETF Liquidity?
Liquidity refers to how easily an asset can be bought or sold in the market without significantly affecting its price. For ETFs, liquidity is influenced by two main factors:
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Trading Volume (Secondary Market Liquidity): How many ETF shares are bought and sold daily on the exchange. Higher volume usually means tighter spreads and lower costs.
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Underlying Holdings Liquidity (Primary Market Liquidity): The liquidity of the securities inside the ETF, such as stocks or bonds. Even if the ETF itself doesn’t trade much, market makers can create/redeem ETF shares based on the liquidity of its underlying assets.
Why Liquidity Matters in ETFs
1. Tighter Bid-Ask Spreads
The bid-ask spread is the difference between what buyers are willing to pay and sellers are asking for. A highly liquid ETF may have a spread as low as 0.01%, while an illiquid ETF could have spreads of 0.5% or higher. Over time, this difference eats into returns.
Example:
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Buying $50,000 of a liquid ETF with a 0.01% spread costs $5.
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Buying $50,000 of a less liquid ETF with a 0.5% spread costs $250.
That’s a huge difference just from liquidity.
2. Easier Entry and Exit
Liquidity ensures that you can buy or sell ETFs quickly without moving the price too much. This is crucial in:
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Market volatility: Liquid ETFs allow you to exit positions smoothly during downturns.
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Large orders: Institutions or high-net-worth investors rely on liquidity to execute trades efficiently.
Even if an ETF has a low expense ratio, poor liquidity can make it more expensive to trade. Investors often focus on management fees but forget about trading costs hidden in spreads and slippage.
4. Diversification Can Mislead
Some niche ETFs, like those focusing on exotic markets or very specific industries, may have great diversification but extremely poor liquidity. Owning such ETFs can become a trap when you want to exit quickly.
Liquidity in Different Types of ETFs
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Broad Market ETFs (e.g., S&P 500, MSCI World): Extremely liquid, low spreads, often the cheapest to trade.
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Sector ETFs (e.g., Tech, Energy, Healthcare): Liquidity depends on sector popularity—tech tends to be highly liquid, niche sectors less so.
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Bond ETFs: Liquidity varies widely; U.S. Treasury ETFs are liquid, while corporate or emerging market bond ETFs may not be.
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International ETFs: May be less liquid if they track markets with lower trading activity.
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Thematic ETFs (e.g., AI, Clean Energy, Metaverse): Can be trendy but often illiquid once hype fades.
Case Study: Liquidity in Action
During the March 2020 COVID-19 market crash, many investors rushed to sell. Broad ETFs like SPY (S&P 500 ETF) remained liquid with tight spreads. In contrast, some niche bond ETFs experienced wider spreads, making it more costly to exit positions.
This highlighted the importance of sticking to ETFs with both strong trading volume and liquid underlying holdings during times of stress.
How to Measure ETF Liquidity
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Average Daily Trading Volume (ADTV): Higher volume generally means higher liquidity.
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Bid-Ask Spread: Always check the difference between buy and sell prices.
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Assets Under Management (AUM): Larger ETFs usually have better liquidity, but this isn’t always guaranteed.
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Underlying Asset Liquidity: Check whether the securities inside the ETF trade frequently (e.g., large-cap stocks vs. small-cap emerging markets).
Global Perspective on ETF Liquidity
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U.S. ETFs: Tend to be the most liquid, especially large funds like SPY, QQQ, or VOO.
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European ETFs: Growing rapidly, but liquidity can vary depending on the exchange (Xetra, LSE, Euronext).
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Asian ETFs: Liquidity is improving in markets like Japan, Hong Kong, and Singapore, but smaller regional ETFs remain less liquid.
For global investors, it’s often best to stick with ETFs listed in larger markets for easier trading.
Risks of Ignoring Liquidity
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Higher Costs: Wide spreads silently reduce returns.
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Difficult Exits: Selling during crises may lock you into poor pricing.
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Volatility Amplification: Illiquid ETFs can swing more than their underlying assets.
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Market Manipulation Risk: In small illiquid ETFs, large trades can distort prices.
FAQs
Q1: Does low trading volume mean an ETF is bad?
Not always. If the underlying assets are liquid, market makers can still provide good pricing. But in practice, low volume often signals higher spreads.
Q2: Should I only buy the most liquid ETFs?
Liquidity is important, but diversification and strategy matter too. Avoid chasing niche ETFs just because they look exciting but lack liquidity.
Q3: Is ETF liquidity the same as stock liquidity?
Similar concept, but ETFs have a creation/redemption mechanism that can provide liquidity even if trading volume looks low.
Q4: How can I check ETF liquidity before buying?
Look at trading volume, spreads, and AUM. Tools from brokers and ETF providers often display this data.
Q5: Are bond ETFs less liquid than stock ETFs?
Yes, generally. Bond markets themselves are less liquid than stock markets, which affects bond ETFs.
Conclusion
Liquidity is more than a technical detail—it’s a hidden cost factor that can significantly impact your long-term ETF returns. Many investors obsess over management fees while ignoring spreads and slippage, which may cost more over time.
Recommendations for Investors:
- Prioritize ETFs with high trading volume and low spreads.
- Stick with large, established ETFs unless you have a strong reason to invest in niche products.
- Always check the liquidity of underlying assets, especially for bond or international ETFs.
- Avoid chasing trends in illiquid thematic ETFs that might trap you later.
- Remember: the cheaper and easier it is to trade, the more efficient your long-term portfolio will be.
By making liquidity a core part of your ETF selection process, you can avoid hidden costs, trade more efficiently, and build a stronger global investment strategy.