Exchange Traded Funds, or ETF’s are securities that hold a collection of different stocks. They are effectively Mutual Funds but without the massive fees.
So, can ETF’s go to zero? Similarly to Mutual funds, ETF’s hold a wide range of stocks and bonds, making them highly diverse. Because of this diversification, it is near to impossible for an ETF to go to zero.
ETF’s are very investor friendly, they may not produce the same returns as single stocks, but historically they have outpaced inflation and been very safe investments. Also the wide range of ETF’s available allows investors like us to passively gain income from small investments in different places.
Are ETF’s as Safe as They Say?
ETF’s in my opinion are one of the safest investments people can make in todays market. They apply the same principle as Mutual funds but without the huge fees.
The amount of cash invested in ETF’s in 2008 was $700 Billion, look at how this has increased in only a ten year period:
|Year||Total Cash Invested ($ Trillions)|
The safest bet is to invest in an indexed fund, most ETF’s are indexed funds but make sure you check them out before buying.
An indexed ETF such as the SPDR S&P 500 ETF (SPY) invests in the exact same securities as the given index, SPY is an S&P 500 ETF, and hence only invests in companies on the S&P 500, so you can be confident SPY will match the S&P 500’s returns for each year.
All investing carries risk, however because indexed ETF’s follow the general trend of the market, and the overall tendency of the market is bullish. Over time indexes are most likely to gain value, so the ETF’s that track them will do the same. Just because ETF’s are exposed to the full volatility of the market, doesn’t mean over long periods of time they don’t yield good returns.
Index ETF’s are also desirable investments because of the low fees. Because the fund follows the trend of an index, it removes the need for fund managers, research staff, and analysts. This is the main difference between Mutual funds and ETF’s.
In regards to ETF’s going to zero, if you are invested in an indexed ETF, unless a global catastrophe occurs that sends the overall economy off a cliff, these investments will never hit zero.
Other Types of ETF
We have already talked about Indexed ETF’s and their benefits. But there are a multitude of different investments you can make, some more risky than others, and some I would avoid completely.
- Index ETF: Holds securities across an index and tracks its progress, hoping to perform in the same way.
- Industry ETF: Tracks particular industries such as technology, banking, or retail sectors. Looks to profit from competition in different industries.
- Bond ETF: Includes government, corporate, municipal bonds. All of which are very safe investments based on bond safety ratings.
- Currency ETF: Invests in foreign currencies hoping to profit from moving exchange rates.
- Commodity ETF: Much like the currency ETF, however invests in commodities such as gold, silver and oil.
- Inverse ETF: Option trading ETF’s, looking to earn gains from shorting stocks. Selling the stock, expecting a decline in value, then repurchasing when it is at a lower price. This is a very complicated strategy and I would not recommend investing in these ETF’s.
- Leveraged ETF: This is where investors are given leverage, or extra capital to trade with inside the ETF’s holdings. If you invest $100 on a 1:3 leverage, any profit you make will be tripled, or likewise any loss you make will be tripled. This can be lucrative if the price goes up, but if the price goes down, you are liable for all the loses.
As I mentioned with the different ETF’s comes different levels of risk. Bond and Index ETF’s are among the safest investments, whereas Inverse and leveraged ETF’s are very risky. By investing in an Inverse ETF you expect stocks to decrease in value, even if the market is generally bullish, and investing in leveraged ETF’s opens you to huge unrealised losses and potential debt to the fund itself.
The pros and cons list for ETF’s is long, here is a summary:
- Low expense ratios and fewer trades required.
- Risk is managed through diversity.
- Invest across a wide range of industries through one vehicle.
- Single industry focus ETF’s can limit diversity.
- Low liquidity which can hinder transactions in and out of the ETF.
What Happens if an ETF goes to Zero?
In the very unlikely event an ETF you are invested in goes to zero, you basically lose you investment.
At the end of the day ETF’s are still companies, that work with the goal of producing profit. If a company doesn’t make any profit they could face financial struggle.
Think of it this way… If Microsoft went bust tomorrow, the share price would go to zero and everyone invested in the stock would lose money. There is a potential Microsoft could pay small amounts to shareholders through liquidation, but not likely.
ETF’s are exactly the same, if the fund loses money and assets, shareholders aren’t going to be happy. The fund would see massive sell offs of the shares, and if fund loses all their investors and the cost of operation is still high, it will be liquidated. Hence hitting zero on the market.
What is ETF Decay?
If you invest in a leveraged ETF, which I strongly wish you wouldn’t, the decay is the loss of your money.
If you invested $1,000 in a 1:4 leverage fund, then the share price of said fund decreased by 5%, your realised loss would be $50, but your unrealised loss would $150, because the leverage is 1:4 meaning a normal 5% loss turns into a 20% loss. This is why I don’t want you to invest in leveraged ETF’s.
The decay is that additional 15% you lost on that investment. It represents the slow and agonising death of your money. Just think, if you invest in a 1:4 leveraged ETF and it has a loss of 25% overnight, that is a 100% unrealised loss, meaning all of your money is gone. It would be even worse if it was a 50% loss… Because then you would owe the fund 200% of your initial investment, so you’ve lost money you didn’t even invest.
Some of the Best Performing ETF’s
Here are the top 5 performing ETF’s from the last decade:
|ETF||ETF Type||Share PricePercentage Growth|
|Invesco QQQ ETF||Industry ETF||366.9%|
|iShares US Medical Devices ETF||Industry ETF||400.1%|
|iShares PHLX Semiconductor ETF||Industry ETF||412.5%|
|SPDR S&P Biotech ETF||Industry ETF||438.3%|
|First Trust Dow Jones ETF||Index ETF||456.6%|
As you can see industry ETF’s lead the way in the last decade. This is probably due to the advances in technology companies and big movements from growth stocks in a bull market. We might see other industries come to light in the next decade, but no one has matched the Dow Jones Index ETF just yet.
Bond ETF’s are generally lower yielding funds but they tend to be more consistent fixed income. Whereas commodity and currency ETF’s have fluctuating incomes.
As of now I have no knowledge of any ETF’s that have hit zero. Hopefully this will never change and we can keep growing with the economy, please contact us if you have any knowledge on ETF’s going to zero.