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How safe are ETFs really?

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How safe are ETFs really?

ETFs are now considered a modern alternative to the traditional savings account – they are uncomplicated, cost-effective, and relatively safe. But does this reputation hold up under closer scrutiny? Many investors want not only attractive returns but also a high degree of security for their money. But can both actually be combined? Can exchange-traded funds offer both return potential and stability? We examine how safe ETFs really are as an investment.

How safe are ETFs really?

How safe are ETFs as an investment?

ETFs are simple, transparent, and cost-effective – no wonder that exchange-traded index funds have become increasingly popular in recent years. Without expensive fund managers, they allow private investors to participate directly in the performance of the capital markets. An ETF always tracks the performance of a specific index, meaning it invests in precisely the companies included in that index – and thus follows its price movements.

Despite these advantages, ETFs, like all capital market products, are not without risk. Therefore, it's understandable that many savers ask: How safe is this form of investment, really?

ETFs and market risk: No protection against losses

An ETF may be broadly diversified, but this doesn't completely protect against price fluctuations. When the market falls, the ETF falls too. While investors benefit from the broad diversification across different sectors, companies, and countries, an ETF is still not immune to losses.

The broader the diversification, the more robust the investment proves to be against individual market events. In times of economic uncertainty, an ETF can usually recover faster than a single stock. However, in global crises – such as a worldwide recession – even broadly diversified ETFs come under pressure.

In the long term, however, it becomes clear that the global economy is growing. Therefore, those who are patient often find ETFs to be a solid investment despite temporary setbacks.

Counterparty and replication risk in ETFs

Not every ETF invests directly in the stocks of the underlying index. Instead, some providers use so-called synthetic replication – an indirect replication via swaps. A swap is an exchange agreement, usually between the ETF provider and a bank: The ETF exchanges the return of its own portfolio for the return of the target index.

An example:
You want to invest in an ETF that tracks the DAX. However, instead of buying German stocks, the ETF invests your money in European stocks and bonds. To still deliver the DAX return to you, the provider makes an agreement with a bank: The bank receives the actual return of the ETF portfolio and, in return, passes on the DAX return to the ETF. This way, as an investor, you receive the same performance as with the DAX – even though your capital isn't actually invested in German stocks.

This method is often cheaper and particularly suitable for markets that are difficult to access. However, the investor bears a so-called risk. Counterparty riskIf the partner bank fails or becomes insolvent, the agreed return may not be paid.

Therefore, those who want to play it safe should prefer physically replicating ETFs – that is, those that actually invest in the stocks of the index.

Keep an eye on currency risks with international ETFs

When you invest your money in international ETFs, you automatically invest in other currencies – for example, US dollars. Changes in the exchange rate between the euro and this foreign currency directly affect your returns. These effects can be profitable, but also detrimental. Therefore, you should always consider the currency risk when investing in globally diversified ETFs.

Does ETFs carry issuer risk?

The so-called issuer risk describes the danger that the issuer of a financial product becomes insolvent – with potential losses for investors.

However, this risk does not exist with traditional ETFs. They are considered segregated assets, which means your invested money remains legally separate from the assets of the fund company. Should the ETF provider become insolvent, your capital is not affected – it does not fall into the insolvency estate and remains protected.

Exception: Swap ETFs
The situation is different with synthetic or swap-based ETFs. These funds use swap agreements with a partner bank to replicate the index performance. If this bank defaults and cannot meet its obligations, this can indeed lead to losses. In this case, there is issuer risk.

That's why ETFs are considered a relatively safe investment.

ETFs (Exchange Traded Funds) offer an attractive combination of security, flexibility, and return opportunities – even if they are not entirely risk-free. However, those who weigh the advantages against the risks quickly understand why ETFs are among the most popular investment options.

1. Wide diversification reduces the risk of loss.
An ETF doesn't just track a single company, but often entire markets or sectors – with dozens or even hundreds of stocks. This diversification ensures that losses in individual stocks are cushioned and the overall risk decreases.

2. Low costs increase net returns.
Because ETFs are passively managed, they incur significantly lower management fees than actively managed funds. Lower costs mean you keep more of the returns you generate.

3. Simple, flexible and tradable at any time
ETFs are traded on the stock exchange like stocks – this makes them particularly accessible. You can buy or sell at any time, without fixed terms or complicated notice periods. Partial withdrawals of your capital are also easily possible.

4. Special assets: Protection in case of insolvency
As mentioned previously, ETFs are considered segregated assets. This means that even if the fund company files for bankruptcy, your invested money remains protected – it does not fall into the bankruptcy estate.

5. Long-term stable development with good return opportunities
Despite financial crises and stock market fluctuations, ETFs have often demonstrated stable growth over the long term. An ETF tracking the MSCI World has historically achieved an average return of 6 to 8 times the market capitalization (%) per year. For the DAX, the range was approximately 6 to 7 times the market capitalization (%), while the S&P 500 even reached 8 to 10 times the market capitalization (%).

Conclusion: How safe are ETFs really?

ETFs are rightly considered a relatively safe investment – thanks to their broad diversification, high transparency, low costs, and protection as segregated assets. They are easy to trade and are particularly attractive for long-term investors. However, ETFs are not without risks: price fluctuations and – in the case of international funds – currency risks are among them. And with swap-based ETFs, there is also issuer risk.

ETFs are therefore not a completely risk-free investment. However, with a well-thought-out selection and a sound investment strategy, the risk can be significantly reduced.

And that's exactly where we support you.
Our consultants from Badent and Klemm We help you invest your assets in a targeted, efficient, and risk-optimized way. Let's find the right investment path together – get in touch now!