Separating the good ETFs from the bad ETFs

— -- Q: What separates the good exchange-traded funds from the bad ones?

A: There's a giant misconception out there about exchange-traded funds or ETFs.

Some investors assume ETFs, mutual-fund like baskets of stocks, are by nature safe investments since they own many stocks. Yet other investors automatically assume ETFs are low-cost and have reasonable fees.

I'm here to tell you that neither of those assumptions are correct.

Starting off with the idea of risk. There are many types of ETFs. Some do invest in the 500 stocks in the Standard & Poor's 500. And yes, those broadly diversified stock ETFs will likely be less risky than any one individual stocks.

But a vast majority of ETFs aren't invested in a broadly diversified basket of stocks. Some own stocks in a particular industry. Some own stocks of a certain market value or size. Others even use complex bets that the stock market will fall. Buying these highly concentrated ETFs can often be very risky.

Some of the ETFs that bet the stock market would fall, for instance, lost 75% or more of their value since the market bottomed in March. That was a crushing blow and a reminder that just because an investment is an ETF, it's not lower risk. You can read about some of these hurting ETFs here: Funds that bet against the bull get gored.

The same goes for industry ETFs. If you own a technology-stock ETF, for instance, if tech stocks tank so will your investment's value. It's true that an ETF might not fall as much as an individual tech stock, but it could tank more.