The lag in the ETF market often refers to two main phenomena. First, you may notice that there is a small lag between the performance of an ETF and its underlying index on a daily basis. Second, over time there is a small performance lag between an ETF and the index it tracks. The former lag tends to minimal and driven by regular market forces. The later is a function of fees that you need to understand before committing capital to such an investment.

The Intraday ETF Lag

Throughout the course of a given trading day, you may notice that there is a very slight lag between changes in an ETF and the index which it tracks. This is less significant for the most liquid and heavily traded ETFs, but it is present regardless. The primary driver of this lag is informational. The managers of an ETF have sophisticated technology that they use to help ensure that there is near perfect correlation between an ETF and the index.

Even with this in place, there is a slight delay in translating the information from one place to the other. With the S&P 500, for example, managers must be mindful of the price action in the futures market. This price action, as well as that of the 500 included stocks, will drive the performance of the index. The index reacts to all of these factors which then must be reflected in the ETF. While technology makes this a near seamless and instantaneous process, there can be a small delay.

The other influence that can create a lag is buying and selling pressure. While an ETF tracks an index, it is not a derivative; it is a stand-alone security that is affecting by market forces like any other stock. When there is an imbalance in these two pressures, there can be a delay between the price of the index and that of the ETF. You will notice this less with highly liquid ETFs, but even there a brief trade imbalance may exist. If there are an excess of buyers, for example, while the index is falling, you will see the ETF falling slightly more slowly.

Long-term Lag

Over time, there will be a small lag in the performance of an ETF relative to the index. This is the result of fees that are charged by the ETF manager. While these fees are usually quite low, you should familiarize yourself with them so as to avoid surprises. They are taken directly out of the ETF, being reflected by a lower price.  The mechanics of the fees means that most investors do not notice them. These fees tend to be more aggressive than those charged by mutual funds for example, but understanding them and their timing is helpful. Over an extended period of time, these fees will result in lower net performance than the index, so if you are estimating returns over the long-term, this should figure in your analysis. When planning for retirement, for example, failing to include these fees may result in a shortfall in your retirement account.

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