How to Reduce the Risks of ETFs

Exchange-traded funds (ETFs), like stocks and index funds, can carry a significant amount of financial risk. The innate appeal of an ETF is that is represents many companies, like an index fund, but it can be traded at any time during trading hours, like a stock. Whether you're holding ETFs for retirement savings or for short time periods, you need to know a few things to reduce their risk.

Difficulty: Moderate

Instructions

1. Avoid selling ETFs in small amounts. You'll have to pay fees on each transaction, just like with stocks. Be careful to avoid transactions of values less than $500 because you may risk having to pay more in fees than you would make on the sale.

2. Buy ETFs that track country finances rather than groups of companies. Many ETF investors buy ETFs that track hundreds of companies in several different industries. You'll minimize ETF risks if you buy these types of shares rather than an ETF that follows just one industry or a handful of companies.

3. Pay attention to the political climate if you invest in foreign ETFs, since an international incident can cause a huge drop in the value of these ETFs. You can also use this information to your advantage to jump on a fast-growing market. For example, a new political leader's support for an industry like alternative energy may cause a quick jump in share prices.

4. Keep enough money in your savings account to cover your expenses for half a year. This safeguard helps you reduce the risk of the worst possible investment scenario. Should all of your investments crash, you'll have enough money saved to cover your cost of living while you rebuild your investments or look for a new job.

5. Reevaluate your ETF portfolio twice a year or annually. You can manage long-term risk by dumping underperforming ETFS and selling a few shares of your profitable ones. Remember that you don't want to have more than 10 percent of your total portfolio value in one ETF fund.

Tips & Warnings

• ETFs have no minimum purchase size. Be sure to distribute your funds across many different investments. You can buy as few as one ETF stock if you want.
• Some ETFs track the performance of an index--like the Dow Jones Industrial Average. However, there is no guarantee that the ETF will match the value of the index that it tracks.
• Avoid using leverage to buy more shares, because borrowed money can greatly increase your financial risks.