Are ETFs without risk? 4 factors to consider

No.

But you probably want more context, right?

Sure, exchange traded funds (ETFs) are often touted as one of the safest and simplest ways to invest. And for good reason—they’ve been around for decades, giving investors low-cost access to markets of all shapes and sizes. State Street Investment Management even launched the very first US ETF back in 1993, and it’s still going strong today.

No investment vehicle is risk-free. Even though ETFs have stood the test of Father Time, it’s still important to consider potential risks before you invest:

1. Liquidity risk: Some ETFs trade less actively, making them harder (and potentially more expensive) to buy or sell.
2. Tracking error: An ETF’s performance may not perfectly match the index it follows.
3. Complexity risk: Certain ETFs (like leveraged or inverse funds) are more complicated and can behave in unexpected ways.
4. Closure risk: Like any investment vehicle, ETFs can shut down if they don’t attract enough assets.

Factors that drive ETF risk

ETFs are designed to make investing easier, but that doesn’t mean they’re invincible. The level of risk you take on depends largely on what’s inside the ETF and how you use it. So what are some of the most common factors that can affect ETF risk? 

Liquidity risk

Some ETFs trade millions of shares every day, which makes them easy to buy or sell at fair prices. The SPDR® S&P 500® ETF (SPY), for example, is the world’s most liquid ETF.¹ But not all ETFs are that active. Niche funds—say, a smaller ETF focused on airlines—may not have as many buyers and sellers.

When that happens, you could have wider bid-ask spreads (the gap between what buyers are willing to pay, and sellers are asking). While this doesn’t mean you can’t trade, it could cost you a little extra.

To visualize this, think of buying and selling shares of a large ETF like shopping at a big-box store: plenty of inventory, always stocked, competitive prices. Trading a thinly traded ETF is more like a corner shop: you might find what you need, but prices can be higher and selection is likely limited.

Tracking error

Indexed ETFs are designed to follow the performance of a specific index. But in practice, they don’t always mirror it exactly. Small differences—from fees, trading costs, or how the ETF replicates its index—can create what’s called tracking error.

For most broad ETFs, tracking error is minor and usually measured in fractions of a percent. But it’s still worth considering so you know why your indexed ETF doesn’t match its index down to the penny.

Complexity risk

While many ETFs are simple index trackers, others use complex strategies that may lead to unexpected outcomes. Examples include:

• Leveraged ETFs: Aim to multiply daily returns (2x, 3x) of an index.
• Inverse ETFs: Designed to move opposite the performance of an index.
• Options-based ETFs: Use options strategies (like covered calls or buffers) to generate income or limit downside.
• Exchange traded notes (ETNs): Structured debt products tied to an index, with issuer credit risk.
• Commodity and currency ETFs: May involve futures contracts or other derivatives rather than direct ownership.

These types of ETFs can be useful tools, however, they’re best suited for investment professionals who regularly use the strategies. For most individual investors, starting with simple index-based ETFs is a better approach.

Closure risk

ETFs may close if they don’t attract enough assets. That said, it’s not incredibly common. For instance, there were 193 US fund closures in 2024,² which is a small percentage (0.02%) of the 10,000+ ETFs that trade globally.³

When closures happen, the fund is liquidated and investors typically receive the cash value of their shares. While you won’t lose everything, it can create tax headaches if capital gains are paid out during liquidation—the kind that not even extra-strength ibuprofen can remedy.

How ETF investors can manage risk

Like any investment, ETFs aren’t risk-free—fortunately, there are simple ways to manage those risks. Here are a few strategies you can use:

• Diversify, diversify, diversify. Putting all your money in one sector or theme is like playing roulette: potential for big paydays or big losses. A broad-market ETF can act like a base or “core” position, while smaller allocations could go toward more specific ideas or themes.
• Know what you own (and know why you own it). Most ETFs publish their holdings daily. Take a quick look under the hood from time to time to understand what’s driving performance. And, just as importantly, document not only your goals but also how your investments support those goals.
• Check liquidity. Larger, more established ETFs generally trade more smoothly and with lower costs.
• Pay attention to fund size. Smaller, newer ETFs are more vulnerable to closure. If you’d rather avoid the hassle, focus on funds with longer track records and higher assets under management (AUM).
• Invest with your goals in mind. Every investor’s journey is different. Defining your goals (whether long-term, short-term, or somewhere in between) can help you choose ETFs that are right for you—and keep you focused when markets shift.

By taking these steps, you can use ETFs to pursue your goals confidently while minimizing unwanted surprises.

Reaching your financial goals starts here

We get it—choosing an ETF can feel like an overwhelming process. These days, investors are inundated with thousands of options. Instead of wondering, “What should I invest in?”, we encourage you to ask a different question: “What’s my goal?”

Or, put another way, where do you want your portfolio to take you?