Is an ETF More Risky Than a Mutual Fund? | Wiser Wealth Management (2024)

FAQs

Is an ETF More Risky Than a Mutual Fund? | Wiser Wealth Management? ›

That's why it's critical that you understand the characteristics of your investments, and not just whether the fund is an ETF or mutual fund. A mutual fund or ETF tracking the same index will deliver about the same returns, so you're not exposed to more risk one way or the other.

While these securities track a given index, using debt without shareholder equity makes leveraged and inverse ETFs risky investments over the long term due to leveraged returns and day-to-day market volatility. Mutual funds are strictly limited regarding the amount of leverage they can use.

ETFs are considered to be low-risk investments because they are low-cost and hold a basket of stocks or other securities, increasing diversification.

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.

If you're paying fees for a fund with a high expense ratio or paying too much in taxes each year because of undesired capital gains distributions, switching to ETFs is likely the right choice. If your current investment is in an indexed mutual fund, you can usually find an ETF that accomplishes the same thing.

Unlike an ETF's or a mutual fund's net asset value (NAV)—which is only calculated at the end of each trading day—an ETF's market price can be expected to change throughout the day. (A mutual fund doesn't have a market price because it isn't repriced throughout the day.)

The choice comes down to what you value most. If you prefer the flexibility of trading intraday and favor lower expense ratios in most instances, go with ETFs. If you worry about the impact of commissions and spreads, go with mutual funds.

Vanguard is paid by the funds to provide administration and other services. If Vanguard ever did go bankrupt, the funds would not be affected and would simply hire another firm to provide these services.

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.

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.

What is the single biggest ETF risk? ›

The single biggest risk in ETFs is market risk.

ETFs are generally lower than those that are charged by actively managed mutual funds because their managers are merely mimicking the contents of an index rather than making regular buy and sell decisions, For some investors, the design of a passive ETF is a negative.

An ETF with a low risk rating can still lose money. ETFs do not provide any guarantees of future performance. As with any investment, you might not get back the money you invested.

The administrative costs of managing ETFs are commonly lower than those for mutual funds. ETFs keep their administrative and operational expenses down through market-based trading. Because ETFs are bought and sold on the open market, the sale of shares from one investor to another does not affect the fund.

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. Consider the two funds below.

ETFs don't often have large fees that are associated with some mutual funds. But because ETFs are traded like stocks, you may pay a commission to buy and sell them, although there are commission-free ETFs in the market. To be fair, mutual funds do offer a low cost alternative: the no-load fund.

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. Receiving an ETF payout can be a taxable event.