Exchange Traded Funds Risks:  Understand What You Are Investing In

Exchange Traded Funds (ETFs) have been one of the most talked about financial products on Wall Street in recent years because Exchange Traded Funds have provided access to a wide variety of investments and asset classes that used to be difficult or impossible for individual investors to access.  However, many investors have brought various Exchange Traded Funds without understanding the substantial Exchange Traded Funds risks that they need to understand prior to investing in Exchange Traded Funds.

Exchange Traded Funds include a wide variety of very different investment products that derive their valuations from many different financial instruments.  Exchange Traded Funds can derive their value from financial instruments that are associated with various asset classes, such as:  stocks, bonds, real estate, and commodities, and can also focus on a particular market segment, region, or country, all of which can cause specific Exchange Traded Funds risks.

Some Exchange Traded Funds carry with them considerably more Exchange Traded Funds risks than others.  It is very important that investors contemplating investing in Exchange Traded Funds read the fund’s prospectus and other sources of information about the fund to gain a clear understanding regarding how the fund derives its value and the specific Exchange Traded Fund risks associated with owning the Exchange Traded Fund.

Exchange Traded Funds Risks:  What To Watch Out For

While not a complete list of Exchange Traded Funds risks, the following are some of the more important Exchange Traded Funds risks that investors need to be aware of:

• Since Exchange Traded Funds are designed to focus on a particular market segment, such as gold, volatility, a segment of the stock market, or a foreign country, Exchange Traded Funds may cause too much concentration and exposure to a particular asset class or segment of the market.  Investment advisors caution against concentrating a great amount of an investment portfolio in any one particular segment or asset class.
• Exchange Traded Funds that invest in futures contracts, such as natural gas or volatility futures, present a unique risk that could cause the value of the Exchange Traded Funds to slowly erode over time, which can cause considerable or even total loss of the principal invested in these types of Exchange Traded Funds.  This risk of loss is due to the fact that futures based Exchange Traded Funds may need to buy more expensive longer dated futures contracts when the near month contracts expire, which can over time compound into considerable or total losses.
• Unlike mutual funds, some Exchange Traded Funds are designed to be leveraged using financial instruments that cause them to move at two or even three times the index or financial product that the Exchange Traded Fund tracks.  While holding leveraged Exchange Traded Funds can be highly profitable when an Exchange Traded Fund is moving in the right direction, the losses can be considerably more than the losses in the index or financial product that a leveraged Exchange Traded Fund tracks.

To avoid excessive Exchange Traded Funds risks, an investor should make sure that they clearly understand how an Exchange Traded Fund derives its valuation and the specific Exchange Traded Funds risks associated with the Exchange Traded Fund under consideration, prior to investing.  For investors uncomfortable with Exchange Traded Fund risks, no-load managed mutual funds that track similar indexes or financial products may be more suitable investments.

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