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Recent jump in interest rates might make you want to dump bond ETFs But market timing is a losing game for most individual investors At least learn the mechanics of bond ETFs before you make a move

A big selling point of ETFs is the fact they give investors the ability to buy and sell stocks, bonds, commodities and currencies during the trading day, unlike traditional mutual funds.

After the financial crisis, some ETF investors sleep better knowing they can sell instantly with the click of a mouse.

Still, just because you can trade ETFs during the day doesn’t mean you should. Academic studies reveal that most individual investors are horrible at timing the market, and that hyperactive trading is counterproductive.

The real attractions of ETFs for long-term investors include their low costs, diversification, tax efficiency and transparency.

Also, the recent sell-off in bonds on indications the Federal Reserve may scale back its monetary stimulus earlier than expected has shown that trading some fixed-income ETFs is even trickier in volatile markets.

Bond ETFs have faced questions about how well they track their underlying assets when investors rushed for the exits as interest rates spiked in late May and June. The funds actually held up quite well under the stress, but the episode is a reminder that investors should probably resist the temptation to dump bond ETFs wholesale in rapidly changing markets.

At the very least, investors need to be knowledgeable about the mechanics of bond ETF trading in unsettled markets, especially the funds tracking less-liquid sectors, such as high-yield corporate debt and municipal bonds.

ETFs publish an intraday net asset value, or NAV, in real time. Investors can compare the NAV against the ETF share price to make sure they’re getting a decent price on the assets they want to buy or sell.

The NAV is simply an estimate of the aggregate value of the securities that the ETF holds, such as a basket of stocks or bonds. The financial institutions that support and trade ETFs have a profit incentive to keep share prices as close as possible to the NAV so that ETF holders get a fair price when they buy and sell.

Yet the share prices of some bond ETFs fell below the NAV during the recent bond rout. Traders call this difference a discount.

However, the discounts do not reveal a flaw in bond ETFs. The mangers of high-yield and muni bond ETFs say the products performed exactly as they should in illiquid markets when seemingly everyone is selling. Their argument is that the discounts are irrelevant because the ETF share price is more accurate than the NAV in these rare situations.

The absence of sufficient liquidity in an asset class hinders the process to price those assets. Unlike U.S.-listed stocks, which typically have relatively active market driven-price discovery during market hours, bonds are usually less liquid, Wells Fargo Advisors said in a recent note.

Some speculative-grade corporate and municipal bonds may not trade for days. This can lead to stale NAVs for ETFs.

If the underlying assets of an ETF product (ETP) become relatively illiquid, there is a potential for significant differences between the share price and the NAV.

Unfortunately, one of the reactions to these periods of disparate performance is the concern by investors that ‘ETPs are not effective instruments to gain access to certain markets.’ However, it is our opinion that the ETP market price most likely provides the more accurate valuation for the underlying assets, Wells Fargo said.

[T]he recent ETF discounts to NAV actually provide strong evidence that ETFs are providing the price discovery ETF proponents tout, added a note from Bernstein Research.

Additionally, some of the ETF discounts arose because of time differentials across markets, Bernstein said. The ETF prices were anticipating lower prices for securities that trade in markets that were closed, while the NAVs were stale.

Investors are accustomed to the prices of individual bonds determining the value of the index or ETF. But when the bonds aren’t trading in a stressed market, the ETF share price can be the leading indicator.

More and more, ETFs are becoming the true market, particularly when market sentiment shifts fast, wrote Mark Wiedman, global head of iShares ETFs at BlackRock, in a letter to investors. In a rapidly moving market, the reported prices of individual underlying assets may become stale. The ETF price can become the true price for that market, and the underlying assets may eventually catch up with any gap between the two.

For ETF providers, the recent confusion over discounts in bond products is a reminder they need to step up their education efforts. ETFs were initially adopted by sophisticated institutional investors, but now more individual investors are using them.

In fact, BlackRock recently launched an education program designed to ensure that more investors understand how ETFs work and their growing role in the markets.

For investors, the recent action in bond ETFs is a reminder that the funds can actually move faster than the markets they’re designed to track. If investors do trade ETFs indexed to illiquid bonds in chaotic markets, they need to do so with their eyes wide open.