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Risks of ETFs

ETFs
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iShares

Summary:  We’ve talked about the advantages of ETFs, but let’s not forget that all investments come with risk. To put it simply, risk affects the value of your investment. More risk can mean more reward but less certainty around the outcome. For every investment decision, you need to be aware of and comfortable with the level of risk to take. We will take you through some of the ways you can prepare for risk when looking at ETFs.


Can you prepare for risk?

The value of your investments can be affected by several things such as stock market movements, political and economic news, company earnings and major corporate incidents. While many of these you may not be able to predict or plan for, a better understanding of your investment choices can potentially minimize the effect of these risks.

What risks should you be wary of?

Capital risk: All financial investments involve an element of risk. Therefore, the value of the investment and the income from it will vary and the initial investment amount cannot be guaranteed.

Tax risks: International taxes will impact your return. Do your research to assess how much your ETF returns may be taxed.

Currency risks: ETFs feature some level of currency risks. International ETFs are priced in local currencies, so changes in exchange rate will impact the value of your investment.

Liquidity risk: Liquidity is the ability to turn an investment into ready cash quickly, with no loss in value. Low liquidity of an ETF s can lead to higher trading costs or difficulty in buying or selling the ETF.

For a regular investor to assess liquidity, you should look at statistics such as:

  • Average bid/ask spreads which is the difference between the buy and sell price of the ETF. In general, the narrower the spread, the more liquid an ETF is.
  • Average trading volume. In general, the higher the volume, the more liquid an ETF is
  • Whether the ETF is trading close to its net asset value, an indication of the fair value of each ETF share the closer it is, the more liquid the ETF is.

If you are an investor who is trading a large quantity of shares at once, the liquidity of the ETF’s underlying securities is the more important factor.

Reducing the risk

You can’t eliminate risk completely but you can reduce it in many ways. Diversification is one of the ways you can do so, by spreading your investments across different sectors, geographies and asset classes. If one sector or asset isn’t performing well, other investments can balance out any potential loss.

However, it is important to note that diversification may not fully protect you from market risk and does not guarantee returns or eliminate potential for loss, so do your research carefully!

Know before you invest…

Before making any investment decisions, it’s important you fully understand the risks involved. Do your research, consult the fund’s offering documents, or talk to a financial advisor to help you make the best choice.

 




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