The Motley Fool

Electronically traded funds are immensely popular among investors and the market has exploded in recent years. But the boom in business isn’t necessarily a good thing. With new funds constantly flooding the market, it is inevitable that some of them will fail.

Fund closures can be a hassle for investors, but the good news is it doesn’t necessarily mean you’ll lose money. Here’s why so many funds go under, and what you can expect if it happens to you:

Why do so many ETFs fail?

With so many ETFs coming out, there are bound to be some duds. The industry’s rapid expansion resulted in a complete over-saturation of the market and some funds just fail to attract enough investors. And when a fund doesn’t have enough investors, it has to shut down.

In general, if you stick with the larger ETFs that track major asset classes, you’ll be safe. But if you go with a niche product or a fund that caters to a smaller market, you may get burned.

How do ETF closures work?

The closing of an ETF is a well-organized process, and the public is given plenty of warning. Typically the notice is sent out about 30 days in advance, which should give investors plenty of time to sell before trading is halted. Here’s how it works:

  • During the time between the announcement and the actual closing, the fund will trade as normal on the appropriate exchange.
  • On the expiration date, the ETF is closed, delisted, and all trading is stopped.
  • After that, liquidation begins and the fund has about two weeks to sell its holdings before cash is paid out to investors.

Wait it out or sell?

In the event a firm shuts down an ETF, investors will have one of two choices: sell your position before trading stops, or wait for the fund to shut down and liquidation to complete.

If investors want some control over the price they get, they may want to sell before trading stops. It should be noted that many sellers will be scrambling to dump their shares and prices can be erratic . . . but waiting for liquidation can lead to even larger losses. In either case, investors will likely also incur additional expenses such as commission fees and unwanted taxes.