What happens if an ETF goes bust?
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.
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.
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.
A leveraged ETF's price can theoretically go negative, but it's extremely rare and usually only happens in extreme market conditions. Leveraged ETFs use financial leverage to amplify the returns of an underlying asset, such as the S&P 500 Index.
When shorting traditional ETFs, you'll sell it with the hopes that the price will fall before you buy it back. Inverse ETFs were created to rise when the value of the target asset falls, and vice versa. But their value depreciates over time, which is over a daily timeline.
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.
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.
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.
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.
Can an ETF lose all its value?
"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.
Leveraged ETFs amplify daily returns and can help traders generate outsized returns and hedge against potential losses. A leveraged ETF's amplified daily returns can trigger steep losses in short periods of time, and a leveraged ETF can lose most or all of its value.
It's important to understand what is meant by “decay” in the context of leveraged ETFs. When we say that a leveraged ETF decays, we mean that its returns can diverge significantly from what we might expect based on the performance of the underlying index.
Short Squeeze: A short squeeze occurs when there is a rapid increase in the price of a heavily shorted ETF. Short sellers rush to cover their positions, buying shares in the market, which can lead to a further price increase. This situation can result in substantial losses for short sellers.
Inverse or leveraged ETFs typically try to track the daily performance of their target asset. So, holding this kind of asset over a long period of time could compound losses. And the higher the leverage of an inverse ETF, the greater the potential decay of value due to its structure.
The value of an ETF, including QQQ, is determined by its net asset value (NAV). The NAV is calculated by dividing the total value of the fund's assets by the number of outstanding shares. As long as the underlying assets of QQQ hold value, it is highly unlikely for the ETF to go to zero.
"The structure of funds means that investors money is held separated from the business itself, it's only if there was an extreme case of negligence or fraud that the money would at risk," says Adrian Lowco*ck, head of personal investing at Willis Owen.
Investors who hold ETFs that are not liquid may have trouble selling them at the price they want or in the time frame necessary. Moreover, if an ETF invests in illiquid shares or uses leverage, the market price of the ETF may fall dramatically below the fund's NAV.
If Vanguard ever did go bankrupt, the funds would not be affected and would simply hire another firm to provide these services.
Too much diversification can dilute performance
Adding new ETFs to a portfolio that includes this Energy ETF would decrease its performance.
What is the 30 day rule for ETFs?
If you buy substantially identical security within 30 days before or after a sale at a loss, you are subject to the wash sale rule. This prevents you from claiming the loss at this time.
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.
In a similar vein, John Authers argued that "the fear is that 'dumb' indexing meekly accepts over-valuations and allows expensive stocks to grow even more expensive; classic ingredients for an investment bubble." But for all the suggestion, ETFs aren't in a bubble (less still a Ponzi scheme).
Stock-picking offers an advantage over exchange-traded funds (ETFs) when there is a wide dispersion of returns from the mean. Exchange-traded funds (ETFs) offer advantages over stocks when the return from stocks in the sector has a narrow dispersion around the mean.
ETFs can form a diverse foundation
The big advantage with ETFs is they offer an unmatched choice of assets, markets, and risk levels. That means there is probably an ETF to match your long-term needs at whatever life stage you are at. ETFs can help you build a strong foundation for your long-term investment portfolio.
