What Are the Risks of Investing in ETFs?

ETFs are generally considered safer than other trading instruments, but they are not without risk

By Andrew Moran

Edited by Korana Braun

Published February 27, 2024

A piggybank next to wooden blocks that read "ETF" next to a block showing a downward arrow to indicate risk

﻿Exchange-traded funds (ETFs) are investment vehicles that pool stocks, bonds, commodities, or other instruments into a single fund. You can buy and sell ETFs throughout a trading session.
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Despite ETFs' popularity, there are risks that investors need to be aware of before building a position in these funds:
﻿Market risk: Like every other type of investment, ETFs can head south really fast due to broader market conditions.
Exotic exposure: The ETF manager might offer some exposure to unconventional instruments, such as currencies, options, and commodities.
Tax risk: In some cases, ETF traders may be notified of certain tax obligations or that they will pay a certain type of levy for the investment.
Concentration risk: Some ETFs may be broad-based and mirror an index, while others might offer exposure to a specific sector. Both offer a set of advantages and disadvantages, but if you are concentrated in a particular sector, this could result in prolonged losses if there is a bear market in this industry.
Tracking error: This might be more technical and perhaps even rare, but tracking errors, which are deviations between position prices and the price trend of a benchmark, do happen.
Counterparty risk: This is when the collateral value slides below the Net Asset Value (NAV) of the ETF when the fund counterparty is in default.
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How to Reduce the ETF RisksDo your research to find the right ETF for your investing needs, from the amount of exposure to certain stocks to the fees you pay
Only invest money you can afford to lose
Use reputable index funds that mirror the benchmark indexes, like the Nasdaq Composite Index or the S&P 500
Avoid ETFs that maintain a prime premium of less than 0.5%
Overall, yes, ETFs are safe. By looking at trading volumes, fees, and the list of holdings, you can determine if an exchange-traded fund (ETF) is right for you.
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