“There is no major study that shows that ETFs are riskier than mutual funds,” says Mackenzie Investments, a Canadian provider of both mutual funds and ETFs. Various factors determine the risk or volatility associated with any fund structure, whether ETF or mutual fund.” In the end, both mutual funds and ETFs’ risk is determined by the underlying stocks.
Investing in markets by purchasing a basket of securities, whether through a mutual fund or an exchange-traded fund (ETF), carries risks.
Inherent risks
The following are some of the potential hazards connected with mutual funds and exchange-traded funds (ETFs) that invest in market-based securities:
ETFs, like mutual funds, are subject to the same market risks as mutual funds. However, the erroneous perception that ETFs are riskier than mutual funds is unfounded and unsupported by any research or statistics.
The human element
Funds that are actively managed are those that are overseen by a professional portfolio manager. These funds have a mandate that they must follow, but the portfolio management team selects, buys, and sells the underlying securities within that mandate. The portfolio manager’s approach, style, and strategy all contribute to the risk of human decision-making.
Traditional mutual funds are actively managed, although index-based (passively managed) mutual funds have been around for a long time. The great majority of ETFs are index-based, but there has been a significant growth of actively managed ETFs hitting Canadian and international markets in recent years.
Focus on the ingredients
If you want to know how spicy a dish is, you wouldn’t ask if it’s served in a bowl or on a plate when dining out in a new restaurant; instead, you’d inquire about the contents.
The same is true when it comes to ETFs and mutual funds’ risk profiles. The underlying holdings, not the structure, are what determine the riskiness of an investment. “There is nothing essentially different about an ETF investment that would expose investors to additional risk when compared to a regular fund,” says TD Asset Management, which offers both mutual funds and ETFs.
Advisors and investors are best served if each investment decision is carefully reviewed based on the investor’s particular goals and circumstances to ensure that the product – whether mutual fund or ETF – satisfies the portfolio’s risk profile.
Is an ETF more risky than a mutual fund?
When compared to hand-picked equities and bonds, both mutual funds and ETFs are considered low-risk investments. While investing in general entails some risk, mutual funds and ETFs have about the same level of risk. It depends on whatever mutual fund or exchange-traded fund you’re investing in.
“Because of their investment structure, neither an ETF nor a mutual fund is safer, according to Howerton. “Instead, the’safety’ is decided by the holdings of the ETF or mutual fund. A fund with a higher stock exposure will normally be riskier than a fund with a higher bond exposure.”
Because certain mutual funds are actively managed, there’s a potential they’ll outperform or underperform the stock market, according to Paulino.
Are exchange-traded funds (ETFs) more volatile than stocks?
Again, it’s hard to give an honest answer to a black-and-white question. In general, an ETF’s diversification makes it less volatile than a single stock. Choosing an ETF that tracks a turbulent market and comparing it to a consistent, well-performing stock, on the other hand, may reveal that the particular stock is less volatile.
Each ETF and each stock must be evaluated on its own merits. Don’t use the same brush to paint all of your investments.
Why invest in an ETF rather than a mutual fund?
Traditional mutual funds have provided several advantages over creating a portfolio one security at a time for nearly a century. Mutual funds offer broad diversification, expert management, minimal costs, and daily liquidity to investors.
ETFs are exchange-traded funds that take mutual fund investment to the next level. ETFs can provide cheaper operating expenses, more flexibility, greater transparency, and higher tax efficiency in taxable accounts than traditional open-end funds. However, there are disadvantages, such as the high cost of trade and the difficulty of knowing the product. Most knowledgeable financial gurus agree that the benefits of ETFs far outweigh the disadvantages.
What are the drawbacks of ETFs?
ETF managers are expected to match the investment performance of their funds to the indexes they monitor. That mission isn’t as simple as it appears. An ETF can deviate from its target index in a variety of ways. Investors may incur a cost as a result of the tracking inaccuracy.
Because indexes do not store cash, while ETFs do, some tracking error is to be expected. Fund managers typically save some cash in their portfolios to cover administrative costs and management fees. Furthermore, dividend timing is challenging since equities go ex-dividend one day and pay the dividend the next, whereas index providers presume dividends are reinvested on the same day the firm went ex-dividend. This is a particular issue for ETFs structured as unit investment trusts (UITs), which are prohibited by law from reinvesting earnings in more securities and must instead hold cash until a dividend is paid to UIT shareholders. ETFs will never be able to precisely mirror a desired index due to cash constraints.
ETFs structured as investment companies under the Investment Company Act of 1940 can depart from the index’s holdings at the fund manager’s discretion. Some indices include illiquid securities that a fund manager would be unable to purchase. In that instance, the fund manager will alter a portfolio by selecting liquid securities from a purchaseable index. The goal is to design a portfolio that has the same appearance and feel as the index and, hopefully, performs similarly. Nonetheless, ETF managers who vary from an index’s holdings often see the fund’s performance deviate as well.
Because of SEC limits on non-diversified funds, several indices include one or two dominant holdings that the ETF management cannot reproduce. Some companies have created targeted indexes that use an equal weighting methodology in order to generate a more diversified sector ETF and avoid the problem of concentrated securities. Equal weighting tackles the problem of concentrated positions, but it also introduces new issues, such as greater portfolio turnover and costs.
Do mutual funds outperform exchange-traded funds (ETFs)?
While actively managed funds may outperform ETFs in the near term, their long-term performance is quite different. Actively managed mutual funds often generate lower long-term returns than ETFs due to higher expense ratios and the inability to consistently outperform the market.
Are ETFs suitable for long-term investment?
ETFs can be excellent long-term investments since they are tax-efficient, but not every ETF is a suitable long-term investment. Inverse and leveraged ETFs, for example, are designed to be held for a short length of time. In general, the more passive and diversified an ETF is, the better it is as a long-term investment prospect. A financial advisor can assist you in selecting ETFs that are appropriate for your situation.
Which is preferable: ETFs or mutual funds?
- Rather than passively monitoring an index, most mutual funds are actively managed. This can increase the value of a fund.
- Regardless of account size, several online brokers now provide commission-free ETFs. Mutual funds may have a minimum investment requirement.
- ETFs are more tax-efficient and liquid than mutual funds when following a conventional index. This can be beneficial to investors who want to accumulate wealth over time.
- Buying mutual funds directly from a fund family is often less expensive than buying them through a broker.
Are ETFs suitable for novice investors?
Because of their many advantages, such as low expense ratios, ample liquidity, a wide range of investment options, diversification, and a low investment threshold, exchange traded funds (ETFs) are perfect for new investors. ETFs are also ideal vehicles for a variety of trading and investment strategies employed by beginner traders and investors because of these characteristics. The seven finest ETF trading methods for novices, in no particular order, are listed below.
Does investing in ETFs increase volatility?
In this study, a one-standard-deviation increase in ETF ownership is linked to a statistically significant increase in daily volatility for S&P 500 equities, ranging from 9% to 15% of a standard deviation. As a result, the effect is economically substantial.