The past decade has seen an explosion in new exchange-traded funds. Investors have flocked to ETFs because they trade like individual stocks, but offer the diversification benefits of mutual funds — all at a low cost.
But once a fund opens it doesn't necessarily stay open forever. Fund closures can create a costly hassle for investors. Here’s what to do if you face an ETF closure — and how to avoid one in the future.
Why are ETFs closing?
The industry’s rapid growth has resulted in some funds that proved to be too niche and failed to attract investors. In 2020, 182 ETFs closed. That being said, there were still 8,552 ETFs in 2021.
If you stick with the largest ETFs that track broad market gauges (like the S&P 500) or major asset classes (like bonds), you may never encounter a fund closure. But, if you get more creative when shopping for ETFs, you could get burned.
How ETF closures work
If the company overseeing an ETF in your portfolio decides to close it, you’re a soon-to-be former shareholder. Perhaps the fund is liquidating because it didn’t generate investor interest or attract sufficient assets to cover administrative costs; regardless, the manager no longer sees a viable business case for the ETF.
The ETF provider will generally announce the fund’s closure by sending notice to shareholders, listing dates when it will stop trading and when its assets will be liquidated.
You have two options:
Sell. Until the ETF stops trading, you can sell shares like normal. The fund will continue to track its underlying index, which helps ensure its price won’t plummet to zero just because of the closure announcement. While you may wish to execute a limit order specifying a minimum selling price, there’s a finite window to execute the trade, so you may not get your desired price.
Await liquidation. You can also simply wait for the fund to be liquidated after its final trading day. The managers will sell all holdings in the fund, settle other obligations and divvy up the balance among remaining shareholders. The price per share from liquidation could differ from the fund’s last trading price, so be aware of this risk.
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Unexpected taxes
The biggest hassle of an ETF closure is it upends your investment timeline, and there’s nothing you can do about it. You’re forced to sell or take liquidation proceeds, which can create a tax burden or lock in investment losses.
You may incur a capital gains tax on profits if the ETF’s in a taxable account, that is, a non-retirement account. If you owned the fund less than a year, the profit will be taxed at your normal tax rate. If you owned it for longer than a year, you’ll pay a lower long-term capital gains rate. On the other hand, if you sell for less than you bought, your loss on this investment can offset gains on others. Ask your tax preparer or a financial advisor for advice.
»MORE: How to pick your next investment
How to avoid an ETF closure
You have plenty of options for ETFs that have very little risk of closing among the top 100 largest ETFs.
These funds have a proven track record, encompassing options that track broad market gauges, different geographies, specific industries or even other assets, like bonds. Among them, assets under management range from $259 billion to $7 billion, with average trading volumes ranging from 70 million-plus shares a day to less than 100,000.
Looking at an ETF that’s not on that list of the top ones? Pay attention to:
Total assets, the amount of money the ETF has attracted in investment.
Average volume, the average number of shares that trade each day.
Inception date, the date this ETF began trading.
ETF provider, the company name associated with the fund.
While there’s no way to predict which funds will close, when researching an ETF on an online broker, look for red flags, including ETFs that:
Haven’t attracted much money in assets.
Have low average trading volume.
Haven’t gained much traction in the time they’ve been trading.
Are from providers that don’t oversee many other funds.
Compare ETFs that compete with one you’re considering to answer these questions.
»MORE: The best brokers for ETF investors
FAQs
You have two options: Sell. Until the ETF stops trading, you can sell shares like normal. The fund will continue to track its underlying index, which helps ensure its price won't plummet to zero just because of the closure announcement.
What happens to my money if an ETF closes? ›
ETFs may close due to lack of investor interest or poor returns. For investors, the easiest way to exit an ETF investment is to sell it on the open market. Liquidation of ETFs is strictly regulated; when an ETF closes, any remaining shareholders will receive a payout based on what they had invested in the ETF.
Can an ETF be closed ended? ›
ETFs are open-ended funds, meaning they can constantly take on new investors and as they do, the fund's assets grow. CEFs have a fixed number of shares that are offered through an IPO. After that, no new shares will be issued and the fund is "closed."
What happens when an ETF is suspended? ›
An ETF shutting down is not the end of the world. The fund is liquidated and shareholders are paid in cash. It's not fun, though. Often, the ETF will realize capital gains during the liquidation process, which it will pay out to the shareholders of record and that could mean an unnecessary tax burden.
What happens if a fund closes? ›
A closed fund may stop new investment either temporarily or permanently. Closed funds may allow no new investments or they may be closed only to new investors, allowing current investors to continue to buy more shares. Some funds may provide notice that they are liquidating or merging.
Has an ETF ever gone to zero? ›
For most standard, unleveraged ETFs that track an index, the maximum you can theoretically lose is the amount you invested, driving your investment value to zero. However, it's rare for broad-market ETFs to go to zero unless the entire market or sector it tracks collapses entirely.
Why is ETF not a good investment? ›
There are many ways an ETF can stray from its intended index. That tracking error can be a cost to investors. Indexes do not hold cash but ETFs do, so a certain amount of tracking error in an ETF is expected. Fund managers generally hold some cash in a fund to pay administrative expenses and management fees.
Can ETFs lose money? ›
Every time you add a single country fund you add political and liquidity risk. If you buy into a leveraged ETF you are amplifying how much you can lose if the investment crashes. You can also easily mess up your asset allocation with each additional trade that you make, thus increasing your overall market risk.
What is the single biggest ETF risk? ›
The single biggest risk in ETFs is market risk.
Can you cash out ETFs? ›
ETF trading generally occurs in-kind, meaning they are not redeemed for cash. Mutual fund shares can be redeemed for money at the fund's net asset value for that day.
The suspension of the shares will have an influence on its value, however, it does not exactly mean that the value of the stock will turn zero. It only results in a ban on trading in an exchange. Suspension on the shares can be revoked if the company manages to comply with all the regulations of the exchanges.
What happens to my ETF if Vanguard fails? ›
The securities that underlie the funds are held by a custodian, not by Vanguard. Vanguard is paid by the funds to provide administration and other services. If Vanguard ever did go bankrupt, the funds would not be affected and would simply hire another firm to provide these services.
Can an ETF ever go negative? ›
In other words, you could potentially be liable for more than you invested because you bought the position on leverage. But can a leveraged ETF go negative? No. If you own a leveraged ETF you can't lose more than your initial investment amount.
What happens if an ETF shuts down? ›
Typically, the issuer will give a minimum of 30 days' notice to allow investors to find an alternative ETF, or to alter their investment strategy. If you own ETF shares, you will receive cash equivalent to the value of your holding on the day of liquidation (not the value on the last day of trading).
What happens if an ETF provider goes bust? ›
You're forced to sell or take liquidation proceeds, which can create a tax burden or lock in investment losses. You may incur a capital gains tax on profits if the ETF's in a taxable account, that is, a non-retirement account. If you owned the fund less than a year, the profit will be taxed at your normal tax rate.
How safe is ETF? ›
Key Takeaways. ETFs can be safe investments if used correctly, offering diversification and flexibility. Indexed ETFs, tracking specific indexes like the S&P 500, are generally safe and tend to gain value over time. Leveraged ETFs can be used to amplify returns, but they can be riskier due to increased volatility.
Are all ETFs closed-end funds? ›
Structure: Unlike closed-end funds, most ETFs are structured as open-end funds and some ETFs are structured as UITs.
How long does it take to get money out of ETF? ›
Once trade settlement is complete, funds will typically arrive in your Cash Account or external bank account in 1-2 business days. It may take longer if, for example, you recently made a deposit or if you are withdrawing to a different bank account than the one used for initial funding.
