Monday, December 23, 2024

Buffer ETFs can shield investors from some losses. Here’s what to know before investing

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If you’re seeking refuge from market volatility, so-called buffer exchange-traded funds provide some downside protection. But these ETFs also limit upside potential and come with higher fees, experts say.  

Buffer ETFs, also known as defined-outcome ETFs, use options contracts to offer investors a pre-defined range of outcomes over a set period. The funds are tied to an underlying index, such as the S&P 500.

These funds have been “one of the fastest-growing areas of the ETF market” over the past five years, with demand surging in 2022 as investors faced correlating losses from stocks and bonds, said Bryan Armour, director of passive strategies research for North America at Morningstar. 

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As of August 2024, there were 327 buffer ETFs, representing more than $54.8 billion in assets, up from 73 such ETFs and roughly $4.6 billion in August 2020, according to data from Morningstar Direct. 

The funds create a ‘buffer zone’

“People need to be aware that if they buy and sell during that period, they might not be getting what they think they’re signing up for,” Armour said.

Plus, buffer ETF investors typically don’t receive dividends, which have contributed up to 2.2% annual returns to the S&P 500 over the past 20 years, according to Morningstar.

Another downside is the assets have higher fees than traditional ETFs, with 0.8% for the average buffer ETF compared to 0.51% for the average ETF, Armour said.

Overall, the biggest drawback is “opportunity cost,” depending on your alternative investment options, he said.

The benefits of buffer ETFs

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