Market Risk

The value of ETFs can fluctuate significantly with the market, meaning they can increase or decrease in value over time. This volatility means there are no guaranteed returns, and your investment can lose value just as easily as it can gain value.

Tracking Difference

Tracking difference refers to the discrepancy between the performance of an ETF (Exchange-Traded Fund) and its benchmark index. It measures how closely the ETF follows the index it aims to replicate A positive tracking difference indicates that the ETF outperformed the index, while a negative value suggests underperformance. Factors such as fees, trading costs, and portfolio composition can contribute to tracking difference.

Liquidity Risk

Even though ETFs are generally liquid, those that invest in assets which are difficult to sell may encounter liquidity issues, making it challenging to buy or sell shares quickly. In this case, the bid-ask spread, which is the difference between the buying and selling prices, can be wide, leading to higher transaction costs. These transaction costs, in return, generally result in higher fees for investors.

Liquidity risk, while a consideration, is generally not a significant concern for long-term investing. This is because long-term investments are held over extended periods, during which short-term fluctuations in liquidity are less impactful. By maintaining a long-term perspective, investors can mitigate the effects of temporary market conditions and focus on the overall growth potential of their investments.

The Risk of Closure

ETFs can be closed down by their issuers if they fail to attract enough assets to cover their operating costs. This risk is more common with niche or specialized ETFs that don’t gain widespread investor interest. When an ETF closes, it can be inconvenient for investors as they may need to find a new investment vehicle and could face unexpected tax consequences.

Complexity of Specialized ETFs

Specialized ETFs, such as leveraged and inverse ETFs, are designed for short-term trading and can pose significant risks for long-term investors due to their daily resetting nature. Additionally, commodity and currency ETFs often employ complex financial instruments, which can increase their risk profile. These complexities make it crucial for investors to thoroughly understand the underlying mechanisms and potential risks before investing in such ETFs.