- Exchange-traded funds (ETFs) are one approach for investors to diversify their portfolios and reduce risk during a recession.
- Consumer staples and non-cyclical ETFs outperformed the broader market during the Great Recession and are expected to do so again in the future.
- We’ll look at just six of the best-performing ETFs from their market highs in 2008 to their lows in 2009.
What should you put your money into during a downturn?
During a recession, you might be tempted to sell all of your investments, but experts advise against doing so. When the rest of the economy is fragile, there are usually a few sectors that continue to grow and provide investors with consistent returns.
Consider investing in the healthcare, utilities, and consumer goods sectors if you wish to protect yourself in part with equities during a recession. Regardless of the health of the economy, people will continue to spend money on medical care, household items, electricity, and food. As a result, during busts, these stocks tend to fare well (and underperform during booms).
When an ETF closes, what happens to your money?
The process of closing an ETF is governed by Securities and Exchange Commission (SEC) regulations. An ETF closure is not the same as a bankruptcy, and in most cases, investors do not lose money as a result of the fund’s closure.
Can ETFs make a loss?
While there are many wonderful new ETFs on the market, anything promising a free lunch should be avoided. Examine the marketing materials carefully, make an effort to thoroughly comprehend the underlying index’s strategy, and be skeptical of any backtested returns.
The amount of money invested in an ETF should be inversely proportionate to the amount of press it receives, according to the rule of thumb. That new ETF for Social Media, 3-D Printing, and Machine Learning? It isn’t appropriate for the majority of your portfolio.
8) Risk of Overcrowding in the Market
The “hot new thing risk” is linked to the “packed trade risk.” Frequently, ETFs will uncover hidden gems in the financial markets, such as investments that provide significant value to investors. A good example is bank loans. Most investors had never heard of bank loans until a few years ago; today, bank-loan ETFs are worth more than $10 billion.
That’s fantastic… but keep in mind that as money pours in, an asset’s appeal may dwindle. Furthermore, some of these new asset types have liquidity restrictions. Valuations may be affected if money rushes out.
That’s not to say that bank loans, emerging market debt, low-volatility techniques, or anything else should be avoided. Just keep in mind while you’re buying: if this asset wasn’t fundamental to your portfolio a year ago, it should still be on the periphery today.
9) The Risk of Trading ETFs
You can’t always buy an ETF with no transaction expenses, unlike mutual funds. An ETF, like any other stock, has a spread that can range from a penny to hundreds of dollars. Spreads can also change over time, being narrow one day and broad the next. Worse, an ETF’s liquidity can be superficial: the ETF may trade one penny wide for the first 100 shares, but you may have to pay a quarter spread to sell 10,000 shares rapidly.
Trading fees can drastically deplete your profits. Before you buy an ETF, learn about its liquidity and always trade with limit orders.
10) The Risk of a Broken ETF
ETFs, for the most part, do exactly what they’re designed to do: they happily track their indexes and trade close to their net asset value. However, if something in the ETF fails, prices can spiral out of control.
It’s not always the ETF’s fault. The Egyptian Stock Exchange was shut down for several weeks during the Arab Spring. The only diversified, publicly traded option to guess on where the Egyptian market would open after things calmed down was through the Market Vectors Egypt ETF (EGPT | F-57). Western investors were very positive during the closure, bidding the ETF up considerably from where the market was prior to the revolution. When Egypt reopened, however, the market was essentially flat, and the ETF’s value plunged. Investors were burned, but it wasn’t the ETF’s responsibility.
We’ve seen this happen with ETNs and commodity ETFs when the product has stopped issuing new shares for various reasons. These funds can trade at huge premiums, and if you acquire one at a significant premium, you should expect to lose money when you sell it.
ETFs, on the whole, do what they say they’re going to do, and they do it well. However, to claim that there are no dangers is to deny reality. Make sure you finish your homework.
What is a very safe exchange-traded fund (ETF)?
Many investors’ portfolios include money market exchange-traded funds (ETFs) because they provide safety and capital preservation in a volatile market. These funds often invest in high-quality, highly liquid short-term debt instruments such as U.S. Treasury bonds and commercial paper, which don’t typically provide much income.
While the majority of money market ETFs’ assets are invested in cash equivalents or highly rated securities with extremely short maturities, some may invest a part of their assets in longer-term or lower-graded securities. Investors should be aware that these securities have more risks.
Despite the fact that all investments come with some risk, the following money market ETFs are a relatively safe choice for investors:
Continue reading to learn more about these investments. The data presented here is current as of May 11, 2021.
What is the most secure ETF?
Investing in the stock market can be a lucrative endeavor, but it’s also possible to lose a significant amount of money in some conditions. The stock market is prone to volatility, and there’s always the possibility that a slump is on the road.
Market volatility, on the other hand, should not deter you from investing. Despite its risks, the stock market remains one of the most straightforward methods to build money over time as long as your portfolio contains the correct investments.
If you’ve been burned by the stock market in the past, it might be time to diversify your portfolio with some new investments. These three ETFs are among the safest and most stable funds on the market, but they can still help you grow your savings.
Are real estate investment trusts safe during a downturn?
It’s crucial to remember that nothing can fully protect you against a recession. Any venture has weaknesses and hazards, and each economic downturn presents new obstacles.
While no recession is the same as the last, there are some real estate sectors that are more robust during a downturn. Real estate investments that meet people’s basic requirements, such as housing and agriculture, or that provide important services for economic activity, such as data processing, wireless communications, industrial processing and storage, or medical facilities, are more likely to weather the storm.
Investors can own and manage properties in any of the asset classes, but many prefer to invest in real estate investment trusts (REITs) (REIT). REITs can be a more affordable and accessible method for investors to enter into real estate while also obtaining access to institutional-quality investments in a diversified portfolio.
Data centers
We live in a data-driven technology era. Almost everything we do now requires data storage or processing, and the demand for data centers will only grow in the next decades as more technological or data-driven gadgets are released. During recessions, more people stay at home to watch TV, use their computers or smartphones, or, in the case of the recent coronavirus outbreak, work from home, increasing the need on data centers. According to the National Association of Real Estate Investment Trusts, there are currently five data center REITs to select from, with all five up 33.73 percent year to date (NAREIT).
Self-storage
Self-storage is widely regarded as a recession-proof asset type. As budgets tighten, some families downsize, relocating to other places to better their quality of life or pursue a new work opportunity, or downsizing by moving in with each other to save money. This indicates that there is a higher need for storage.
The COVID-19 pandemic, on the other hand, has had an unforeseen influence on the storage industry. While occupancy has remained high, eviction moratoriums and increasing cleaning and safety costs have resulted in lower revenues. According to NAREIT, self-storage REITs are down 3.51 percent year to date. However, this industry is expected to recover swiftly, particularly for companies like Public Storage (NYSE: PSA), the largest publicly traded self-storage REIT, which has a strong credit rating and a diverse portfolio.
Warehouse and distribution
E-commerce has altered the way our economy works. Demand for quality warehousing and distribution centers has soared as more consumers purchase from home than ever before. Oversupply of industrial space, particularly warehouse and distribution space, is a risk, given that this sector has been steadily growing for the past decade; however, as a result of COVID-19, it has already proven to be the most resilient asset class of all commercial real estate, making it an excellent choice for a recession-resistant investment. Prologis (NYSE: PLD), one of the major warehousing and logistics REITS, and Americold Realty Trust (NYSE: COLD), a REIT that specializes in cold storage facilities, have both proven to be quite durable in the present economic situation, with plenty of space for expansion.
Residential housing
People will always require housing. Residential housing, which can range from single-family homes to high-rise flats or retirement communities, fulfills a basic need that is necessary even in difficult economic times. During economic downturns, rents may stagnate and evictions or foreclosures may increase, but residential rentals are a relatively reliable and constant source of income. Despite the COVID-19 challenges, American Homes 4 Rent (NYSE: AMH), which specializes in single-family rental housing, and Equity Residential (NYSE: EQR), which specializes in urban high-rises in high-density areas, are two of the largest players in residential housing, both of which have maintained high occupancy and collection rates.
Agriculture
Aside from housing, agriculture and food production are two additional critical services on which our country and the rest of the world rely. Our existing food system is primarily reliant on industrial agriculture, but more and more autonomous and regenerative agricultural projects are springing up, allowing for more crop diversification, increased productivity, and reduced economic and environmental risk.
Wireless communication
Wireless communication has grown into a giant sector, with American Tower (NYSE: AMT) and Crown Castle International (NYSE: CCI) being two of the world’s largest REITs. Cell tower REITs that provide telecommunication services are an important part of our world today, and while growth prospects can be difficult to come by, very good track records and rising demand make this a terrific real estate investment that will weather any economic downturn.
Medical facilities
Medical facilities, senior housing, hospitals, urgent care clinics, and surgery centers all provide a vital service that will always be in demand, even during economic downturns.
Retail centers
Before you abandon ship when you see this category, let me state unequivocally that retail is not dead, at least not in all forms. Grocery stores and other retail outlets that provide critical services and products will continue to be in demand, as they did during the last pandemic. The issue here is for retail REITs to invest in the vital service sector with such focus that other sectors such as tourism, restaurants, or general shopping and goods do not put the company or investment at risk.
Who profited from the financial crisis of 2008?
Warren Buffett declared in an op-ed piece in the New York Times in October 2008 that he was buying American stocks during the equity downturn brought on by the credit crisis. “Be scared when others are greedy, and greedy when others are fearful,” he says, explaining why he buys when there is blood on the streets.
During the credit crisis, Mr. Buffett was particularly adept. His purchases included $5 billion in perpetual preferred shares in Goldman Sachs (NYSE:GS), which earned him a 10% interest rate and contained warrants to buy more Goldman shares. Goldman also had the option of repurchasing the securities at a 10% premium, which it recently revealed. He did the same with General Electric (NYSE:GE), purchasing $3 billion in perpetual preferred stock with a 10% interest rate and a three-year redemption option at a 10% premium. He also bought billions of dollars in convertible preferred stock in Swiss Re and Dow Chemical (NYSE:DOW), which all needed financing to get through the credit crisis. As a result, he has amassed billions of dollars while guiding these and other American businesses through a challenging moment. (Learn how he moved from selling soft drinks to acquiring businesses and amassing billions of dollars.) Warren Buffett: The Road to Riches is a good place to start.)
How long should an ETF be held?
- If the shares are subject to additional restrictions, such as a tax rate other than the normal capital gains rate,
The holding period refers to how long you keep your stock. The holding period begins on the day your purchase order is completed (“trade date”) and ends on the day your sell order is executed (also known as the “trade date”). Your holding period is unaffected by the date you pay for the shares, which may be several days after the trade date for the purchase, and the settlement date, which may be several days after the trade date for the sell.
- If you own ETF shares for less than a year, the increase is considered a short-term capital gain.
- Long-term capital gain occurs when you hold ETF shares for more than a year.
Long-term capital gains are generally taxed at a rate of no more than 15%. (or zero for those in the 10 percent or 15 percent tax bracket; 20 percent for those in the 39.6 percent tax bracket starting in 2014). Short-term capital gains are taxed at the same rates as your regular earnings. However, only net capital gains are taxed; prior to calculating the tax rates, capital gains might be offset by capital losses. Certain ETF capital gains may not be subject to the 15% /0%/20% tax rate, and instead be taxed at ordinary income rates or at a different rate.
- Gains on futures-contracts ETFs have already been recorded (investors receive a 60 percent / 40 percent split of gains annually).
- For “physically held” precious metals ETFs, grantor trust structures are employed. Investments in these precious metals ETFs are considered collectibles under current IRS guidelines. Long-term gains on collectibles are never eligible for the 20% long-term tax rate that applies to regular equity investments; instead, long-term gains are taxed at a maximum of 28%. Gains on stocks held for less than a year are taxed as ordinary income, with a maximum rate of 39.6%.
- Currency ETN (exchange-traded note) gains are taxed at ordinary income rates.
Even if the ETF is formed as a master limited partnership (MLP), investors receive a Schedule K-1 each year that tells them what profits they should report, even if they haven’t sold their shares. The gains are recorded on a marked-to-market basis, which implies that the 60/40 rule applies; investors pay tax on these gains at their individual rates.
An additional Medicare tax of 3.8 percent on net investment income may be imposed on high-income investors (called the NII tax). Gains on the sale of ETF shares are included in investment income.
ETFs held in tax-deferred accounts: ETFs held in a tax-deferred account, such as an IRA, are not subject to immediate taxation. Regardless of what holdings and activities created the cash, all distributions are taxed as ordinary income when they are distributed from the account. The distributions, however, are not subject to the NII tax.