ETF Investors Face Serious Risk

ETF Investors Face Serious Risk with Both Inverse ETFs and Leveraged ETFs

Exchange traded funds (ETFs), which were originally designed for and are exceptionally popular with institutional investors, are increasingly being marketed to and purchased by individual investors – a fact the SEC and FINRA find disturbing.

Recently, the two organizations issued a joint investor alert that warned individual investors of the potential risks associated with ETFs, particularly leveraged or inverse ETFs. (For more information, read the full alert here.)

Exchange traded funds are complicated and risky products, and the differences between them are so intricate that it can be almost impossible for individual investors to understand the specifics of any one ETF well enough to compare it to another. In the alert, the SEC and FINRA warned individual investors about the products’ inherent complexities and advised investors to “evaluate each investment closely and not assume all ETFs are alike.”

While most ETFs are registered investment companies whose shares represent an interest in a portfolio of securities that track an underlying benchmark or index, not all are. Some ETFs, particularly those that invest in commodities or currencies, are unregistered – a fact investors should be aware of if they want to protect themselves from fraud.

Investors who choose to invest in an ETF should be aware that they are investing in a high-risk product. Common ETF investment strategies involve short sales, swaps, futures contracts, and other derivatives, all of which can expose the ETF and its investors to significant risk.

Long-term and intermediate investors should be particularly wary of non-traditional ETFs, said the SEC and FINRA. “Because leveraged and inverse ETFs reset each day, their performance can quickly diverge from the performance of the underlying index or benchmark. In other words, it is possible that you could suffer significant losses even if the long-term performance of the index showed a gain,” warned the regulators in the alert.

Additional risks ETF investors should be aware of include: potentially costly fees and expenses, potential tax consequences, and the possibility that the ETF will not meet its stated objective for the trading day.

For additional information on investing in ETFs, click here.