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
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.
What happens if an ETF provider fails? ›
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.
Can ETFs be close 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 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.
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.
What happens if ETF defaults? ›
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).
Why I don't invest in ETFs? ›
Less Diversification
For some sectors or foreign stocks, ETF investors might be limited to large-cap stocks due to a narrow group of equities in the market index. A lack of exposure to mid- and small-cap companies could leave potential growth opportunities out of the reach of certain ETF investors.
Is an ETF safer than a stock? ›
Because of their wide array of holdings, ETFs provide the benefits of diversification, including lower risk and less volatility, which often makes a fund safer to own than an individual stock. An ETF's return depends on what it's invested in. An ETF's return is the weighted average of all its holdings.
What are the risks of closed-end funds? ›
Valuation Risk: The market price of a CEF at any point in time is likely to vary from the fund's NAV. The size of any price premium and/or discount could have a significant impact on an investor's return over time.
Nearly all leveraged ETFs come with a prominent warning in their prospectus: they are not designed for long-term holding. The combination of leverage, market volatility, and an unfavorable sequence of returns can lead to disastrous outcomes.
How many ETFs have closed? ›
There are a few reasons why ETFs generally die. Low assets under management, high fees, poor performance, and short track records are closely associated with the probability of closure. In 2023, there were 244 ETF closures with an average age of 5.4 years and average assets under management of only $54 million.
What happens to my money if an ETF closes? ›
Because the ETF is a separate legal entity from the issuer that manages it, the ETF will control all the assets in its portfolio up until the date set for its liquidation, at which point the manager will sell the assets and distribute the proceeds to investors.
What is a final close? ›
Definition: The final close occurs when the VC firm has reached its target fund size or decides to close the fund, even if it falls short of the target. Purpose: At the final close, fundraising efforts officially conclude, and the VC firm has a clear picture of the total committed capital available for investments.
What is the truth about closed-end funds? ›
A closed-end fund manager does not have to hold excess cash to meet redemptions. Because there is no need to raise cash quickly to meet unexpected redemptions, the capital is considered to be more stable than in open-end funds. It is a stable capital base.
Is it possible to lose money on ETF? ›
All investments have a risk rating ranging from low to high. An ETF with a low risk rating can still lose money. ETFs do not provide any guarantees of future performance. As with any investment, you might not get back the money you invested.
Can an ETF 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.
Are ETFs safer than stocks? ›
Because of their wide array of holdings, ETFs provide the benefits of diversification, including lower risk and less volatility, which often makes a fund safer to own than an individual stock. An ETF's return depends on what it's invested in. An ETF's return is the weighted average of all its holdings.
Is it bad to hold ETF long term? ›
Nearly all leveraged ETFs come with a prominent warning in their prospectus: they are not designed for long-term holding. The combination of leverage, market volatility, and an unfavorable sequence of returns can lead to disastrous outcomes.
