ETFs and Risk

• ETFs are risky securities. There are no guarantees that your investment will hold its value. The government does not stand behind ETFs, or any other risky security, though it may guarantee individual bonds that an ETF holds. This is not true for any ETF that invests in stock indexes, however. Anything you invest in ETFs is subject to the possibility of loss. However, while a 100 percent loss in any given ETF is a theoretical possibility, in actuality, it is extremely unlikely. For you to suffer a 100 percent loss in an ETF, every security in the ETF would have to become worthless. An entire market would have to disappear.
  
  

Leverage

• It is very possible, however, to lose all your money in an ETF if you have employed leverage. Leverage is the use of borrowed money to purchase securities. For example, if you have invested $100,000 in your brokerage account into an ETF, and then borrowed another $100,000 and invested in the same ETF, you would lose your entire investment if the ETF's value fell by 50 percent. You would be left with $100,000 in ETF assets and be liable to pay back the $100,000 you owe, leaving a net value of zero. Leverage magnifies positive returns. But it also magnifies risk.
  
  

SIPC Protection

• Even if the ETFs themselves do not lose value, it is possible for a brokerage to go bankrupt or for a broker to steal investors' money. To protect yourself against this loss, use brokers who are members of SIPC, the Securities Investor Protection Corporation. SIPC insures investors against brokerage fraud and insolvency, replacing lost securities if a broker or brokerage firm commits theft or goes bankrupt.
  
  

Special ETFs

• Use caution when investing in specialized ETF products, including leveraged ETFs and inverse ETFs. Leveraged ETFs feature built-in leverage and are designed for intraday trading, not long-term investing. The investment company combines your money with borrowed money to buy the securities that comprise the fund. Your gains are magnified, but so is your risk. Due to the volatility of the underlying index, the price of a leveraged ETF will decay over time and approach zero. Over the first half of 2009, for instance, a 3X leveraged ETF tracking the financial sector lost about 57 percent of its value even though the underlying index rose about 0.9 percent. Inverse ETFs are special ETFs that use short selling contracts to move in the opposite direction of the market, which means if markets rise, you will lose money. There is no upward limit to the amount any given index could rise, which means your losses could be severe. Costs and fees in these ETFs can also be significantly higher than other ETF options. These costs can be a severe hindrance on long-term returns.
  
  

Alternatives

• For additional protection against loss, consider Treasury bonds, which are backed by the full faith and credit of the United States Treasury. The U.S. Treasury has a AAA credit rating and is widely considered the safest investment in the market. Their prices can be volatile if you don't hold them to maturity -- especially for longer-term issues. But payment of interest and repayment of principal is assured. Alternatively, consider fixed annuities and whole life insurance cash value, which are guaranteed by the issuing insurance company's general fund. State governments also insure these balances in state guaranty funds, though specifics vary by state. Lastly, you could invest in tangible items, such as real estate, livestock, gold or other assets that would retain value in the event of a general economic collapse.