Why are ETFs more risky than mutual funds?
In general, ETFs can be more risky than mutual funds because they are traded on stock exchanges. Their value can fluctuate throughout the day in response to market conditions. This means that if the market takes a dip, the value of your ETF could drop quickly, and you could experience significant losses.
Market risk
The single biggest risk in ETFs is market risk. Like a mutual fund or a closed-end fund, ETFs are only an investment vehicle—a wrapper for their underlying investment. So if you buy an S&P 500 ETF and the S&P 500 goes down 50%, nothing about how cheap, tax efficient, or transparent an ETF is will help you.
While they can be actively or passively managed by fund managers, most ETFs are passive investments pegged to the performance of a particular index. Mutual funds come in both active and indexed varieties, but most are actively managed. Active mutual funds are managed by fund managers.
For instance, some ETFs may come with fees, others might stray from the value of the underlying asset, ETFs are not always optimized for taxes, and of course — like any investment — ETFs also come with risk.
ETFs are considered to be low-risk investments because they are low-cost and hold a basket of stocks or other securities, increasing diversification.
Both are less risky than investing in individual stocks & bonds. ETFs and mutual funds both come with built-in diversification. One fund could include tens, hundreds, or even thousands of individual stocks or bonds in a single fund. So if 1 stock or bond is doing poorly, there's a chance that another is doing well.
The single biggest risk in ETFs is market risk.
ETFs may close due to lack of investor interest or poor returns. For investors, the easiest way to exit an ETF investment is to sell it on the open market. Liquidation of ETFs is strictly regulated; when an ETF closes, any remaining shareholders will receive a payout based on what they had invested in the ETF.
Mutual funds are largely a safe investment, seen as being a good way for investors to diversify with minimal risk. But there are circ*mstances in which a mutual fund is not a good choice for a market participant, especially when it comes to fees.
In terms of safety, neither the mutual fund nor the ETF is safer than the other due to its structure. Safety is determined by what the fund itself owns. Stocks are usually riskier than bonds, and corporate bonds come with somewhat more risk than U.S. government bonds.
Why are ETFs better than mutual funds?
Key Takeaways. Many mutual funds are actively managed while most ETFs are passive investments that track the performance of a particular index. ETFs can be more tax-efficient than actively managed funds due to their lower turnover and fewer transactions that produce capital gains.
ETFs offer numerous advantages including diversification, liquidity, and lower expenses compared to many mutual funds. They can also help minimize capital gains taxes. But these benefits can be offset by some downsides that include potentially lower returns with higher intraday volatility.
Low Liquidity
If an ETF is thinly traded, there can be problems getting out of the investment, depending on the size of your position relative to the average trading volume. The biggest sign of an illiquid investment is large spreads between the bid and the ask.
The biggest hassle of an ETF closure is it upends your investment timeline, and there's nothing you can do about it. You're forced to sell or take liquidation proceeds, which can create a tax burden or lock in investment losses.
Leveraged ETF prices tend to decay over time, and triple leverage will tend to decay at a faster rate than 2x leverage. As a result, they can tend toward zero.
Summary. ETFs are not less safe than other types of investments, like stocks or bonds. In many ways, ETFs are actually safer, for instance thanks to their inherent diversification. And by choosing the right mix of ETFs, you can control the market risk to match your needs.
"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.
Holding too many ETFs in your portfolio introduces inefficiencies that in the long term will have a detrimental impact on the risk/reward profile of your portfolio.
Key differences between stocks and ETFs
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.
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.
What is the safest ETF to invest in?
- Vanguard S&P 500 ETF (VOO 1.12%) ...
- Vanguard High Dividend Yield ETF (VYM 1.03%) ...
- Vanguard Real Estate ETF (VNQ 0.68%) ...
- iShares Core S&P Total U.S. Stock Market ETF (ITOT 1.12%) ...
- Consumer Staples Select Sector SPDR Fund (XLP 1.0%)
- Initial public offerings (IPOs)
- Venture capital.
- Real estate investment trusts (REITs)
- Foreign currencies.
- Penny stocks.
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.
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.
The license to run a mutual fund house is given after due diligence in a similar way as banks get the banking license. In short, a mutual fund house is as safe as a bank. Mutual funds don't guarantee capital protection or fixed returns.
