Can you lose money buying ETFs?
Market risk
Leveraged and inverse ETFs are designed for short-term trading and use complex strategies. These ETFs amplify market movements and can lead to substantial losses if they do not perform as expected.
At any given time, the spread on an ETF may be high, and the market price of shares may not correspond to the intraday value of the underlying securities. Those are not good times to transact business. Make sure you know what an ETF's current intraday value is as well as the market price of the shares before you buy.
In other words, you could potentially be liable for more than you invested because you bought the position on leverage. But can a leveraged ETF go negative? No.
ETFs can be a great investment for long-term investors and those with shorter-term time horizons. They can be especially valuable to beginning investors. That's because they won't require the time, effort, and experience needed to research individual stocks.
Interest rate changes are the primary culprit when bond exchange-traded funds (ETFs) lose value. As interest rates rise, the prices of existing bonds fall, which impacts the value of the ETFs holding these assets.
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.
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.
Because of their wide array of holdings, ETFs provide the benefits of diversification, including lower risk and less volatility, which often makes a fund safer to own than an individual stock. An ETF's return depends on what it's invested in. An ETF's return is the weighted average of all its holdings.
ETFs offer advantages over stocks in two situations. First, when the return from stocks in the sector has a narrow dispersion around the mean, an ETF might be the best choice. Second, if you are unable to gain an advantage through knowledge of the company, an ETF is your best choice.
Has an ETF ever failed?
In fact, 47% of all such funds have closed down, compared with a closure rate of 28% for nonleveraged, noninverse ETFs. "Leveraged and inverse funds generally aren't meant to be held for longer than a day, and some types of leveraged and inverse ETFs tend to lose the majority of their value over time," Emily says.
How long should you keep ETFs? It depends on your investment goals and how long you want to stay invested in ETFs. While a long-term ETF holding for more than three years can get you better returns, short-term returns can also be more for some ETFs.
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.
In contrast, the riskiest ETF in the Morningstar database, ProShares Ultra VIX Short-term Futures Fund (UVXY), has a three-year standard deviation of 132.9. The fund, of course, doesn't invest in stocks. It invests in volatility itself, as measured by the so-called Fear Index: The short-term CBOE VIX index.
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.
If you don't want to put a lot of effort into managing your investments, then S&P 500 ETFs are a good solution. But if you're willing to do the work, then you might do even better in the long run with a portfolio of hand-picked stocks (although, the odds are against you).
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.
- Invesco QQQ Trust (QQQ)
- Vanguard Information Technology ETF (VGT)
- Invesco AI and Next Gen Software ETF (IGPT)
- MicroSectors FANG+ Index 3X Leveraged ETN (FNGU)
- Vanguard U.S. Quality Factor ETF (VFQY)
- WisdomTree Japan Hedged Equity Fund (DXJ)
All investments carry some risk, and Vanguard ETFs are no exception. But Vanguard is a fund provider with a reliable company history, and well-diversified ETFs tend to be safer than individual stocks.
ETFs are more liquid (easy to buy and sell) than mutual funds. Online brokers make it easy to buy or sell ETFs with a simple click of the mouse. It can be extremely complicated to invest in individual bonds, but a bond ETF can make the fixed-income portion of your portfolio very easy.
Are ETFs a safe bet?
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.
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.
Experts agree that for most personal investors, a portfolio comprising 5 to 10 ETFs is perfect in terms of diversification.
| TICKER | NAME | % Change |
|---|---|---|
| BND | Vanguard Total Bond Market ETF | -0.056% |
| SCHD | Schwab U.S. Dividend Equity ETF | -0.343% |
| VTI | Vanguard Total Stock Market ETF | -0.592% |
| IJR | iShares Core S&P Small-Cap ETF | 0.369% |
One of the ways that investors make money from exchange traded funds (ETFs) is through dividends that are paid to the ETF issuer and then paid on to their investors in proportion to the number of shares each holds.
