Understand Unique Risks of Single Stock ETFs
The DC Department of Insurance, Securities and Banking (DISB) wants consumers to be aware of the risks related to Single Stock Exchange-Traded Funds (ETFs). While an ETF sounds like a simple “single” investment, it comes with enhanced risks; including lack of diversification, daily resets, leveraged structure, active trading needs, and compounding losses.
What is a Single Stock ETF?
Single Stock ETFs track the performance of a single underlying security in contrast to most ETFs that track the performance of multiple securities. They pay positive or negative multiples of the market performance of the underlying stock. That means a single ETF holder has a leveraged position and faces a greater exposure to market volatility than just simply holding that single stock. And typically, Single Stock ETFs are not designed to be held for more than one day. The value of a Single Stock ETF resets daily, adding another layer of risk with instant realization of losses, as it closes daily and redeems ETF shares.
What Does a Single Stock ETF Look Like?
Suppose that Fleetza Pizza, Inc. is traded on an exchange, and there are two different Single Stock ETFs based on Fleetza’s stock price. The first Single Stock ETF is a 2x leveraged, and the second is a 2x inverse leveraged fund. On Monday, if Fleetza’s stock price goes up 10% from $100 to $110 per share, the 2x leveraged Single Stock ETF would earn 20%, and go to $120 per share, while the 2x inverse Single Stock ETF would lose 20%, thus dropping to $80 per share. On Tuesday, the Single Stock ETFs reset their respective prices, and begin trading again.
The profit or loss you can experience from investing in a single stock ETF can greatly increase when the stock's price fluctuates. This profit or loss is determined at the end of each day when the stock market closes, and it is reflected in your investment account daily. That is why single Stock ETFs are meant to be actively traded. They are not designed to be long-term holds.
Know the Risks
Single Stock ETFs:
- Are not in the best interest of long-term investors
- Lack diversification
- Pose leveraged and compounding losses
The Bottom Line
Be careful when you invest in a complex product. If you cannot afford to lose your investment largely, use caution. Contact DISB for resources that will help you understand the risks associated with Single Stock ETFs. For more information, visit disb.dc.gov or finra.org/investors/insights/lowdown-leveraged-and-inverse-exchange-traded-products.
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