Mar 13, 2018
Assessing Risk: Are ETFs Volatile?
What are ETFs?
To first understand the volatility of ETFs we have to have a basic understand of what ETFs are.
Exchange-traded funds (ETFs) are securities that trade like common stocks. These funds are designed to track a specific index, commodity, or group of assets. Since ETFs are traded on the market they can experience price changes throughout day to day trading.
Prices changes are the data points used to calculate volatility. (What’s volatility?) So, on a very basic level, ETFs are volatile in the sense that the price of an ETF is not fixed. Of course, when people ask, “Are ETFs volatile?” they are often really asking, “Is there a lot of risk in ETFs?”
The answer to that question is not so black and white.
Each ETF is different
Since ETFs are designed to track a specific index or commodity it is impossible to directly compare two different ETFs and declare them volatile or not.
You know the saying, “Comparing apples to oranges?” A bond ETF may be less volatile than an ETF that tracks small-cap stocks. Then again, an ETF that focuses on the energy sector may be more volatile than a ETF that tracks health care stocks. You need to do your research because no two ETFs are alike in terms of volatility and risk.
What determines the volatility of an ETF?
The sector or market an ETF tracks will play a major role in determining the volatility of an ETF.
For example, an ETF designed to track a volatile commodity (what’s a commodity?) will itself be a volatile investment.
Cannabis ETFs aim to track the highly volatile legal marijuana market and, therefore, will mimic the volatility of that market. This can mean major highs followed by rapid drops in value. Changes in the law or enforcement of laws could have a huge effect on the entire cannabis market and, in turn, have an effect on the price of any ETFs that are tracking the market.
An ETF of U.S. Treasuries may be less volatile because such bonds are backed by a promise to pay from the federal government. However, yields on Treasuries tend to be lower, because they are generally considered less risky investments.
The major driver of volatility in an ETF is the underlying index, commodity, or asset that is being tracked. To say that ETFs are either highly volatile or not volatile at all would be an inaccurate statement as no two ETFs are exactly the same.
Are ETFs volatile? Yes, they are in the sense that their price can change from day to day. Some ETFs may show a very small amount of volatility while others may be very volatile.
With that said, since ETFs track very large markets or commodities with a wide diversity of companies, they tend to be less volatile than choosing a single stock.
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