What's the downside of ETFs?
ETFs are designed to track the market, not to beat it
ETFs are subject to market fluctuation and the risks of their underlying investments. ETFs are subject to management fees and other expenses. Unlike mutual funds, ETF shares are bought and sold at market price, which may be higher or lower than their NAV, and are not individually redeemed from the fund.
There are many ways an ETF can stray from its intended index. That tracking error can be a cost to investors. Indexes do not hold cash but ETFs do, so a certain amount of tracking error in an ETF is expected. Fund managers generally hold some cash in a fund to pay administrative expenses and management fees.
All investments have a risk rating ranging from low to high. An ETF with a low risk rating can still lose money. ETFs do not provide any guarantees of future performance. As with any investment, you might not get back the money you invested.
Bottom Line. Leveraged ETFs decay due to the compounding effect of daily returns, volatility of the market and the cost of leverage. The volatility drag of leveraged ETFs means that losses in the ETF can be magnified over time and they are not suitable for long-term investments.
For most standard, unleveraged ETFs that track an index, the maximum you can theoretically lose is the amount you invested, driving your investment value to zero. However, it's rare for broad-market ETFs to go to zero unless the entire market or sector it tracks collapses entirely.
ETFs make a great pick for many investors who are starting out as well as for those who simply don't want to do all the legwork required to own individual stocks. Though it's possible to find the big winners among individual stocks, you have strong odds of doing well consistently with ETFs.
The low investment threshold for most ETFs makes it easy for a beginner to implement a basic asset allocation strategy that matches their investment time horizon and risk tolerance. For example, young investors might be 100% invested in equity ETFs when they are in their 20s.
If Vanguard ever did go bankrupt, the funds would not be affected and would simply hire another firm to provide these services.
Key Takeaways. ETFs can be safe investments if used correctly, offering diversification and flexibility. Indexed ETFs, tracking specific indexes like the S&P 500, are generally safe and tend to gain value over time. Leveraged ETFs can be used to amplify returns, but they can be riskier due to increased volatility.
Do ETFs go down in a recession?
ETFs. Investment funds are a strategic option during a recession because they have built-in diversification, minimizing volatility compared to individual stocks. However, the fees can get expensive for certain types of actively managed funds.
Investors looking to weather a recession can use exchange-traded funds (ETFs) as one way to reduce risk through diversification. ETFs that specialize in consumer staples and non-cyclicals outperformed the broader market during the Great Recession and are likely to persevere in future downturns.
For most ETFs, selling after less than a year is taxed as a short-term capital gain. ETFs held for longer than a year are taxed as long-term gains. If you sell an ETF, and buy the same (or a substantially similar) ETF after less than 30 days, you may be subject to the wash sale rule.
Q: How does the wash sale rule work? If you sell a security at a loss and buy the same or a substantially identical security within 30 calendar days before or after the sale, you won't be able to take a loss for that security on your current-year tax return.
Nearly all leveraged ETFs come with a prominent warning in their prospectus: they are not designed for long-term holding. The combination of leverage, market volatility, and an unfavorable sequence of returns can lead to disastrous outcomes.
Experts agree that for most personal investors, a portfolio comprising 5 to 10 ETFs is perfect in terms of diversification.
There are a few reasons why ETFs generally die. Low assets under management, high fees, poor performance, and short track records are closely associated with the probability of closure. In 2023, there were 244 ETF closures with an average age of 5.4 years and average assets under management of only $54 million.
Since they maintain a fixed level of leverage, 3x ETFs eventually face complete collapse if the underlying index declines more than 33% on a single day. Even if none of these potential disasters occur, 3x ETFs have high fees that add up to significant losses in the long run.
A single ETF can contain dozens or hundreds of different stocks, or bonds or almost anything else considered an investable asset. Since ETFs are more diversified, they tend to have a lower risk level than stocks.
You expose your portfolio to much higher risk with sector ETFs, so you should use them sparingly, but investing 5% to 10% of your total portfolio assets may be appropriate. If you want to be highly conservative, don't use these at all.
What's the best ETF to buy right now?
| Exchange-traded fund (ticker) | Assets under management | Expenses |
|---|---|---|
| Vanguard Dividend Appreciation ETF (VIG) | $78.2 billion | 0.06% |
| Vanguard U.S. Quality Factor ETF (VFQY) | $324.3 million | 0.13% |
| SPDR Gold MiniShares (GLDM) | $6.8 billion | 0.10% |
| iShares 1-3 Year Treasury Bond ETF (SHY) | $24.8 billion | 0.15% |
Neither mutual funds nor ETFs are perfect. Both can offer comprehensive exposure at minimal costs, and can be good tools for investors. The choice comes down to what you value most. If you prefer the flexibility of trading intraday and favor lower expense ratios in most instances, go with ETFs.
At least once a year, funds must pass on any net gains they've realized. As a fund shareholder, you could be on the hook for taxes on gains even if you haven't sold any of your shares.
There is no transfer of ownership because investors buy a share of the fund, which owns the shares of the underlying companies. Unlike mutual funds, ETF share prices are determined throughout the day. A mutual fund trades only once a day after market close.
The majority of individual investors should, however, seek to hold 5 to 10 ETFs that are diverse in terms of asset classes, regions, and other factors. Investors can diversify their investment portfolio across several industries and asset classes while maintaining simplicity by buying 5 to 10 ETFs.
