The biggest risk of ETFs is market risk. Like an investment fund or a fixed capital fund, ETFs are just an investment vehicle, a wrapper for your underlying investment. So, if you buy an S&P 500 ETF or a Gold IRA and the S&P 500 falls by 50%, nothing cheap, fiscally efficient or transparent an ETF is will help you. Market risk also belongs to the risk group of ETFs and refers to the risk of general price movements in a market, such as a stock market. All stocks, bonds or ETFs are influenced by general market movements; if the entire market goes down or up, your investment may also react.
Retail investors often underestimate concentration risk. This means that your portfolio's volatility will increase if you invest in just a few stocks. Even if you invest in several stocks, you may suffer significant concentration risk if these stocks come from a few sectors, countries, currencies, or investment styles. Securities lending is another category of ETF risks that is often overlooked.
Some ETF managers lend ETF stocks or bonds to other parties. These other parties could be hedge funds that speculate on the fall in the stock price. While securities lending generates benefits for you, the investor, there is also a small risk of loss if the borrowing party were to go bankrupt. In some cases, splitting up loans is often more advantageous for the issuer.
Jolien Brouwer analyzes equity lending, one of the main risk factors for ETFs. Despite these benefits, note the risks involved in such investments. Not all investment decisions will be made as expected, but diversification can be a key tool for managing risk. The best way for an investor to address indexed risk is to understand what the index contains and the rules that govern what enters or leaves the index, as indicated in the documentation of the exchange-traded fund.
If the underlying shares of publicly traded investments are in a currency other than the denominated currency, investors will face exchange rate risk. However, an investment that seems very attractive in terms of potential return may not be the right choice if it involves unacceptably high risk. A risk that some analysts fear may be on the horizon is a situation in which the vast majority of investments are destined for passive indexed investments using ETFs. In addition to the risk that their investment will be exposed to index movements, investors are also at risk when the ETF or ETC does not match the index's performance, a situation known as a tracking error.
Before making a decision to invest, you should ensure that you fully read and understand the prospectus, supplement and key information document for relevant investors, including the risks associated with investing. You should ensure that you fully understand any investment and the associated risks before making the decision to invest. The following section discusses some of the risks that apply when investing in exchange-traded funds and publicly traded commodities. ETCs tend to be riskier investments because commodity prices can move more than 10% in a single day.
In short, if you create a diversified portfolio and avoid synthetic ETFs or ETFs that are dedicated to lending securities and remain invested for an extended period, you can create a portfolio that seeks to minimize the risks of ETFs. It is crucial to understand that there is an inevitable trade-off between investment return and risk. Although this is not always the case, in general terms, the level of return on your investments will reflect the underlying risk. .
