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📘 Chapter 8: Risks in ETFs – What Can Go Wrong & How to Stay Safe
ETFs are powerful tools for wealth creation — low cost, transparent, and easy to trade.
But ETFs are not risk-free.
Most beginners think:
“ETF tracks index, so no risk.”
That’s half-truth.
In this chapter, we’ll clearly explain all major ETF risks, with real-life examples and simple solutions, so you can invest confidently and safely.
Also Read: How to Select the Right ETF – Step-by-Step Guide for Indian Investors (2026)
⚠️ Why Understanding ETF Risks Is Important
Risk doesn’t mean “loss guaranteed”.
Risk means “what can go wrong if you don’t understand the product.”
Smart investors don’t avoid risk —
👉 they manage it.
🔴 Risk 1: Market Risk (The Biggest One)
This is the core risk in all ETFs.
If the market or index falls, the ETF will also fall.
📉 Example:
- Nifty 50 falls 20%
- Nifty 50 ETF also falls ~20%
No fund manager can save you here — because ETFs are passive.
✅ How to Manage:
- Invest with long-term view (5+ years)
- Don’t panic sell during corrections
- Use SIP-style investing in ETFs
🔴 Risk 2: Tracking Error (Silent Return Killer)
Tracking Error = Difference between ETF return and its index return.
📊 Example:
- Index return = 12%
- ETF return = 11.2%
➡️ Tracking error = 0.8%
This happens due to:
- Expense ratio
- Cash holding
- Rebalancing delay
- Dividend handling
⚠️ Why It Matters:
Small tracking error every year = big loss over long term.
✅ How to Manage:
- Choose ETFs with low tracking error (<0.5%)
- Prefer large, established ETFs
- Check AMC factsheets regularly
🔴 Risk 3: Liquidity Risk (Very Important for India)
Some ETFs look good, but nobody trades them.
Low trading volume causes:
- Difficulty buying/selling
- Large bid-ask spread
- Price different from NAV
📉 Example:
You want to sell ETF at ₹100
But buyer available only at ₹96
➡️ Forced loss = Liquidity risk
✅ How to Manage:
- Always check daily trading volume
- Prefer ETFs with high AUM + high volume
- Avoid very new or niche ETFs initially
🔴 Risk 4: Price vs NAV Risk
ETF price is decided by market demand & supply, not directly by NAV.
Sometimes:
- ETF trades above NAV (premium)
- ETF trades below NAV (discount)
This usually happens when:
- Liquidity is low
- Market volatility is high
✅ How to Manage:
- Check Indicative NAV (iNAV) before trading
- Avoid market orders in low-volume ETFs
- Use limit orders instead
🔴 Risk 5: Sector & Thematic ETF Risk
Sectoral and thematic ETFs look exciting:
- Banking ETF
- IT ETF
- PSU / Infra ETF
But they are highly concentrated.
📉 Example:
If banking sector underperforms for 2 years,
Bank ETF can stay flat even when Nifty rises.
✅ How to Manage:
- Use sector ETFs only as small portion (10–20%)
- Avoid all-in bets
- Combine with broad market ETFs
🔴 Risk 6: International ETF Risks
International ETFs add global power — but also extra risks.
🌍 Main Risks:
- Currency Risk
- USD-INR movement affects returns
- Foreign Market Risk
- US or global recession
- Regulatory Limits
- International investment caps
📊 Example:
- Nasdaq index rises 10%
- Rupee strengthens 5%
➡️ Net return ≈ 5%
✅ How to Manage:
- Treat international ETFs as diversification, not core
- Limit exposure to 10–20%
- Invest with long-term horizon
🔴 Risk 7: Debt ETF Risks (Often Ignored)
Debt ETFs are not 100% safe.
Main Risks:
- Interest Rate Risk
- Credit Risk (for corporate bond ETFs)
📉 Example:
When interest rates rise,
bond prices fall → debt ETF NAV falls.
✅ How to Manage:
- Prefer Bharat Bond / G-Sec ETFs
- Match ETF maturity with your goal
- Avoid low-rated bond ETFs
🔴 Risk 8: Behavioral Risk (Investor’s Own Mistake)
This is the most dangerous risk — YOU.
Common mistakes:
- Buying ETF after big rally
- Panic selling during correction
- Chasing “best ETF” every year
- Over-trading ETFs like stocks
✅ How to Manage:
- Stick to plan
- Don’t react to daily price moves
- ETFs reward patience, not excitement
🧠 Onetrader Risk Rule
“ETFs don’t destroy wealth.
Impatience and ignorance do.”
🧾 Quick Summary – ETF Risks & Solutions
| Risk | What It Means | How to Control |
|---|---|---|
| Market Risk | Index falls | Long-term view |
| Tracking Error | Lower returns | Choose low-error ETFs |
| Liquidity Risk | Hard to sell | High volume ETFs |
| NAV Deviation | Wrong price | Limit orders |
| Sector Risk | Concentration | Small allocation |
| Global Risk | Currency & policy | Limited exposure |
| Debt Risk | Rate changes | High-quality bonds |
| Behavior Risk | Panic decisions | Discipline |
🚀 Final Thoughts
ETFs are excellent tools, but only when you understand their risks.
Once you:
- choose liquid ETFs
- control emotions
- invest with discipline
ETFs become one of the safest long-term wealth creators.
Knowledge reduces risk more than diversification ever will.
🔜 What’s Next?
Now that you understand ETF risks,
the next step is action.
👉 Next Chapter (Chapter 9): How to Buy & Sell ETFs – Practical Demo (India)
We’ll cover:
- How to buy ETFs step-by-step
- Market order vs limit order
- Best time to trade ETFs
- Common beginner mistakes