ETFs can be attractive, but they're never a sure bet

— -- Q: When I want to bet on a certain investment theme, such as the recovery of U.S. automakers, I liked to buy an exchange-traded fund (ETF) to reduce my risk. But sometimes there's not an ETF available. Why not?

A: Exchange-traded funds, or ETFs, can do many great things for your portfolio. But they're not miracle workers.

Like mutual funds, ETFs own baskets of stocks, which spreads your risk over many companies or investments. And ETFs often have low fees and may be tax efficient.

But, ETFs do have limitations and aren't the answer to all your investment needs. Not all ETFs will lower your portfolio's risk, and some charge high fees. And if there aren't enough companies to put into an ETF, the ETF cannot by created due to regulatory requirements.

Don't expect anyone to create a U.S. automaker ETF with just GM and Ford, as the rules require ETFs to contain more than two stocks. Certainly, you might imagine a U.S. automotive ETF that owned shares of companies in the auto industry, such as parts suppliers. But again, you really wouldn't be lowering your risk since the suppliers' fortunes are linked to the automakers'.

There is a misconception that if you buy an ETF, you're magically taking dramatically less risk. That's not necessarily the case.

If an ETF owns stocks that move in tandem, you're only reducing your risk marginally. That's the beauty of ETFs that own the 500 stocks in the Standard & Poor's 500. You're owning shares of companies in all industry sectors, from health care to technology, which cuts your exposure to single industry problems. Meanwhile, you're saving on costs because the ETF's expense ratio is well below the commissions you'd pay to buy shares in 500 companies.