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How Risky are ETFs?

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The August 24 “flash crash” has some industry experts questioning the safety of ETFs, according to a Wall Street Journal article. ETFs, or exchange-traded funds, offer investors the diversification of a closed-end mutual fund but differ in that they trade on exchanges all day like stocks. Beyond offering the ability to trade like stocks, ETFs have expense ratios that tend to be lower than those of the average mutual fund and greater tax efficiency.

After their inception 23 years ago, there is roughly $2 trillion invested in ETFs. While traditional mutual funds still dominate with nearly $13 trillion in assets, investors have already added $200 billion to ETFs this year, according to The Wall Street Journal.

The relative tranquility of the ETF marketplace was shattered on August 24, 2015, when the “flash crash” caused the price of many ETFs to diverge from their underlying value. For example, the iShares Dow Jones U.S. Index Fund (IYY) closed on Friday, August 21, at $99.36. The following Monday, the Dow Jones Industrial Average plunged nearly 1,000 points, triggering halts in many stocks held by ETFs. Unable to keep up with the frantic pace, the IYY plummeted over 46% from Friday’s close, trading at $53.42 on an intraday basis, well below its net asset value.

This was not the first time ETFs have experience trouble in turbulent markets. During the flash crash of 2010, dozens of ETFs (and other stocks) fell as low as a penny a share. In 2013, municipal-bond ETFs traded at a discount to their net asset values during the “taper tantrum,” when bond yields jumped.

According to the article, some financial advisers say they are now wary about recommending the products to clients. In addition, the ETF industry is facing increased scrutiny from regulators and financial professionals.

“It may be time to re-examine the entire ETF ecosystem,” Securities and Exchange Commissioner Luis Aguilar said at the opening of the SEC’s Investor Advisory Committee meeting in October.

The Wall Street Journal article addresses many of the concerns regarding ETFs and whether they are legitimate. In addition, there are suggestions on how ETF investors can protect themselves from market volatility.

For those looking to take advantage of the benefits ETFs offer, AAII has a wealth of resources, including:

These articles are only a few examples of the many benefits of AAII membership. To learn more, consider a risk-free 30-day Trial AAII Membership to start becoming an effective manager of your own assets.

 

 

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