Risks of ETFs
Like any other investments, ETFs are also associated with a certain degree of risk. Some of the risks that surround ETFs include:
1. Market Risk: ETFs being investment funds are subject to market risk. This means that any change in the market condition directly affects the market value of the ETFs. If any market index or sector shows poor performance, the value of ETFs of that sector is adversely affected, incurring losses to the investors.
2. Liquidity Risk: Although it is said that ETFs are freely traded on a stock exchange, but their liquidity depends on the trading volume and market activity. ETFs that have low trading volume are difficult to sell at desired prices, especially at a time of market downfall.
3. Tracking Error: ETFs are designed to track the performance of various indexes, but in reality, the ETFs indexes show a slight difference between the benchmark performance and the performance of ETFs. Such deviation in performance may spoil the expectation of the investors in terms of return.
4. Interest Rate Risk: ETF’s investment in fixed-income securities earns a fixed interest at a specific period of time, but is also subject to Interest Rate Risk. When the rate of interest on such securities rises, the market value of such ETFs decreases causing a loss to the investors.
5. Tax Risks: ETFs are subject to taxes and may increase the tax burden of the investors. If the ETFs earn a handsome amount of capital gain, the tax burden of the investor multiplies. In addition to this ETFs having a high portfolio turnover creates a tax burden on the shoulder of investors, even if ETF shares are not been sold.
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