A Guide to ETF Liquidation (2024)

Since the first ETF began trading in the U.S. in 1993, exchange-traded funds (ETFs) have become one of the most popular investment vehicles available to individual investors.

By the end of August 2023, there were 9,904 global ETFs. But 244 ETFs closed in 2023.

Read on to learn what happens when an ETF shuts down.

Key Takeaways

  • Introduced in the U.S. in 1993, ETFs have become one of the most popular investment choices for investors.
  • 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.
  • Receiving an ETF payout can be a taxable event.

Reasons for ETF Liquidation

The top reasons for closing an ETF are a lack of investor interest and a limited amount of assets.

For example, investors may avoid an ETF because it is too narrowly-focused, too complex, too costly, or has a poor return on investment. They may prefer a broader market-tracking ETF with solid year-to-year returns from a well-known investment company.

And when ETFs with dwindling assets no longer are profitable, the investment company may decide to close out the fund. Generally speaking, ETFs tend to have low profit margins and therefore need sizeable amounts of assets under management (AUM) to make money.

Although ETFs are generally considered lower risk than individual securities, they are not immune to problems such as tracking errors and the chance that certain indexes may slow other market segments or active managers.

$54 million

The average amount of assets under management held by ETFs that failed in 2023. The average age of these ETFs was 5.4 years.

The Liquidation Process

ETFs that close down must follow a strict and orderly liquidation procedure. The liquidation of an ETF is similar to that of an investment company, except that the fund also notifies the exchange on which it trades that trading will cease.

Notification

Shareholders typically receive notification of the liquidation between a week and a month before it occurs, depending on the circ*mstances. The board of directors, or trustees of the ETF, will confirm that each share is individually redeemable upon liquidation since they are not redeemable while the ETF is still operating. They are redeemable in creation units.

Redeeming Shares

Investors who want out of their investment upon notice of an ETF's impending liquidation can sell their shares on the open market. A market maker buys the shares and they are redeemed.

Those shareholders who don't close their position in the ETF while it is still traded will receive their money, most likely in the form of a check. The amount of a liquidation distribution is based on the number of shares an investor held and the net asset value (NAV) of the ETF.

Tax Consequences

The liquidation can create a tax event, if an ETF is held in a taxable account. So investors may owe capital gains taxes on any profits received when their shares are redeemed.

4 Ways To Identify an ETF on the Way Out

It is possible to reduce your chances of owning an ETF that may close and then having to search for another place to stash your cash.

The following four tips can help investors determine whether an ETF is likely to face some trouble:

1. Be alert to ETFs that track narrow market segments. These products are considered risky and therefore require careful evaluation.

2. Examine an ETF's trading volume. Volume is a good indicator of liquidity and investor interest. If the volume is high and the price is rising, the ETF most likely is liquid and people want to own it. That can be a good sign of ETF vitality.

3. Look at the AUM to determine how much money fund managers have to work with to achieve returns that please investors. High and growing levels of AUM can point to a fund's success and its ability to attract greater numbers of investors.

4. Review an ETF's prospectus, to understand what type of investment you are holding. Typically available upon request, the prospectus will provide information about fees and expenses, investment objectives, investment strategies, risks, performance, pricing, and other information.

Are ETFs Good for Beginners?

Yes, ETFs are a popular investment choice for inexperienced beginning investors because they do not require a great deal of time or effort to manage. For example, instead of having to research and select stocks yourself (or pay someone to do so), the ETF that you buy with a single, convenient purchase will already be invested in a broad range of stocks in which you're interested. And most ETFs typically have low expense ratios.

How Long Do You Have To Hold an ETF?

There is no required minimum holding period for an ETF. But you should be careful about trading an ETF too frequently. If you buy an ETF within 30 days of selling the same or a substantially similar security, you may run the risk of breaking the wash sale rule, which would prevent you from claiming a loss on your taxes. Holding an ETF for longer than a year may get you a more favorable capital gains tax rate when you sell your investment.

How Do You Choose a Good ETF?

When choosing an ETF, investors typically look at the underlying index, risk profile, and portfolio composition to determine if the fund aligns with their investment goals. It is also important to look at the fund's management costs. The lower the expense ratio, the better the return for the investor.

The Bottom Line

In the U.S., ETFs have been around since the early 1990s. They provide investors with an array of attractive features—instant diversification, low costs, the flexibility of intraday trading, and more. Yet, even while new ETFs may be launched, others may shut down.

If you find yourself holding an ETF that is being closed, there's no reason to panic. You'll get your money back and can search for another ETF in which to invest.

A Guide to ETF Liquidation (2024)

FAQs

What happens if an ETF is liquidated? ›

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. Receiving an ETF payout can be a taxable event.

Has an ETF ever gone to zero? ›

Leveraged ETF prices tend to decay over time, and triple leverage will tend to decay at a faster rate than 2x leverage. As a result, they can tend toward zero.

How do you calculate liquidity of an ETF? ›

This liquidity is visible through metrics such as trading volume, market depth, and the bid-ask spread. High trading volumes and narrow bid-ask spreads frequently signify good liquidity, making it easier and cost-effective for investors to trade.

How many ETFs have failed? ›

In 2023, there were 244 ETF closures with an average age of 5.4 years and average assets under management of only $54 million. They lost 4.8 percentage points on average over the trailing one year before liquidation—a poor showing indeed.

What are the risks of ETF liquidation? ›

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. There will also be transaction costs, uneven tracking, and various other grievances.

How long does it take to liquidate an ETF? ›

Liquidate immediately: Selling your shares before the closure date allows you to reinvest the principal more quickly, since the standard settlement for ETFs traded on national exchanges is just two business days.

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.

Why I don't invest in ETFs? ›

Commissions and Expenses

Every time you buy or sell a stock, you might pay a commission. This is also the case when it comes to buying and selling ETFs. Depending on how often you trade an ETF, trading fees can quickly add up and reduce your investment's performance.

Can you lose your investment in ETF? ›

Portfolio Risks

4 If you buy into a leveraged ETF you are amplifying how much you can lose if the investment crashes. 1 You can also easily mess up your asset allocation with each additional trade that you make, thus increasing your overall market risk.

Which ETF has the highest liquidity? ›

Research carried out by Cafemutual shows that Nippon India Mutual Fund has the highest average trading volume across ETF categories. In the large cap ETF space, Nippon India ETF Nifty 50 BeES has the highest average trading volume of Rs. 66 crore.

What are the most traded ETFs? ›

US ETFs that have been traded the most
SymbolVol * PriceExpense ratio
SPY D31.337 B USD0.09%
QQQ D16.175 B USD0.20%
IWM D7.329 B USD0.19%
HYG D2.438 B USD0.49%
39 more rows

Why are ETFs illiquid? ›

If an ETF invests in securities that have limited supply or are difficult to trade, this may impact the market makers' ability to create or redeem units of the ETF which may then affect the portfolio's liquidity.

What is the riskiest ETF? ›

7 risky leveraged ETFs to watch:
  • ProShares UltraPro QQQ (TQQQ)
  • ProShares Ultra QQQ (QLD)
  • Direxion Daily S&P 500 Bull 3x Shares (SPXL)
  • Direxion Daily S&P 500 Bull 2x Shares (SPUU)
  • Amplify BlackSwan Growth & Treasury Core ETF (SWAN)
  • WisdomTree U.S. Efficient Core Fund (NTSX)
Jul 7, 2022

Has anyone gotten rich from ETFs? ›

Can ETFs really make you rich? In a nutshell: Yes, ETFs alone are enough to make you rich. With just one investment, you can capture the growth of the overall stock market or a certain segment of it. For example, you can find ETFs that focus on pretty much any industry, investment theme, or region of the globe.

Is it bad to invest in too many ETFs? ›

The disadvantages are complexity and trading costs. With so many ETFs in the portfolio, it's important to be able to keep track of what you own at all times. You could easily lose sight of your total allocation to stocks if you hold 13 different stock ETFs instead of one or even five.

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 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 when a stock is removed from an ETF? ›

Rebalancing typically involves selling some of the ETF's holdings in the stock that is being removed, and using the proceeds to buy shares of the stock that is being added. This process helps to ensure that the ETF continues to track the index it is designed to follow.

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