Investors Are Overlooking a Big Problem With New ETFs

Volatility is a fact of life in financial markets. There’s no way to avoid it. We see it all the time in the day-to-day price movements of stocks, indexes, and exchange-traded funds. Most of the time, those movements are small, inconsequential, and boring, though they usually compound in a positive direction over time.

Bigger movements tend to grab headlines, and for good reason. Large gains can make life-changing money. That’s the big reason a dearth of volatile ETFs has made way to exchanges. Many are betting on a fast profit, but there’s a downside. ETFs with potentially massive upside can experience a similar, if not greater, downside. Speculating with ETFs is a risky proposition.

An Imperfect Metric

Volatility is often expressed using the standard deviation of an investment’s return. It incorporates the range of possible outcomes and their probabilities. In doing so, it reasonably sizes up the riskiness of an investment.

The distribution of those probabilities has a bell shape: Moderate rates of return are more common, while those that are larger in magnitude, both positive and negative, occur less frequently. The chart below shows the bell-shaped distribution for the monthly returns of Vanguard S&P 500 ETF VOO going back to September 1976 (the historical returns of the mutual fund were used to increase the size of the dataset).

VOO's Bell Curve

Standard deviations, when applied to financial markets, are imperfect. They assume returns follow a normal distribution, so they don’t accurately reflect the true probabilities of extreme events or the wild ups and downs that markets experience.

For example, Vanguard S&P 500 ETF returned negative 7 percentage points or worse in about 4.6% of the months between September 1976 and October 2025. However, that probability drops to 3.2% if its returns fit a normal distribution. In other words, months when Vanguard S&P 500 ETF was down by an extreme amount occurred more frequently than a normal distribution model would suggest. The same goes for its upside. Vanguard S&P 500 ETF has historically experienced extreme positive rates of return more frequently than its standard deviation dictates.

The gap between theory and reality may look small—it was just 1.4% for the extreme down months—but the magnitudes of those returns are large and can have lasting effects. Small differences matter.

Speculation

The potential for extreme out- or underperformance at the tails of a bell curve informs a lot of the new ETFs that trade today. Volatility has characterized many of the 940-plus new ETFs launched over the first 11 months of 2025. Morningstar Direct classifies about 30% of them as trading tools, while another 5% land in the digital assets (cryptocurrencies) category. Nearly all crank up volatility compared with an ETF tracking the broader stock market. They’re prime candidates for speculation.

The volatility of these ETFs is intended, as they must possess huge upside potential to entice buyers. Increasing volatility increases the magnitude of returns at the extreme ends of the bell curve. It opens the door to higher highs and lower lows.

The appetite for speculation is nothing new. Edwin Lefèvre’s 1923 investing classic, Reminiscences of a Stock Operator, follows the tumultuous stock market bets made by its protagonist, Larry Livingston, a character modeled after the infamous trader Jesse Livermore.

It’s tough to define Livingston’s (or Livermore’s) tack. Many would call him a day trader, while others might describe him as a trend follower or momentum investor. It’s not much of a stretch to compare him with a gambling addict. The results of his efforts look no different. He made, and lost, multiple fortunes betting on stocks over the course of his life.

There’s an important lesson here. Speculating can create life-changing wealth, but it’s incredibly risky and unreliable, and it often leads to ruin.

The irony of the story is that Livingston was very aware of the speculative nature of his endeavors. He nodded to the long history of stock market speculation in the book’s opening chapter:

“Another lesson I learned early is that there is nothing new in Wall Street. There can’t be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again. I’ve never forgotten that.”

Livingston’s observation rings true. There has been no shortage of speculations over the centuries. Tulips, railroads, internet stocks, mortgages, and Beanie Babies count themselves among speculative fads.

The object of speculation has shifted over time, but the proclivity toward it remains alive and well. The money parked in ETFs classified as trading tools, which are mostly ETFs providing leveraged or inverse exposure to an asset, has nearly quadrupled over the past six years from $36 billion in January 2020 to more than $140 billion at the end of November 2025.

Trading Tool ETFs Grow

These ETFs are perniciously risky. They can produce high rates of return on a given day, but they are also highly unpredictable and destroy money over the long run. All of them eventually grind toward zero and are not suitable for a long-term investor.

The Wrong Lesson

That said, why are they so popular? There are many answers to that question, and they’re likely all correct to some degree. Some of the popularity is tied to the desire to speculate, which cannot be ignored. It’s also reasonable to assume that not everyone using these ETFs understands the risks they’re taking. They’re only looking at the potential reward and not acknowledging the risk.

The market environment of the past several years might also play a role. Vanguard S&P 500 ETF’s standard deviation of daily returns from January 2020 through November 2025 was 21%. That’s considerably higher than its long-term 17.5% standard deviation going back to Sept. 1, 1976.

That’s a dramatic step up the volatility ladder, but it makes sense. Over the past six years, the world has endured a pandemic, the onset of a ground war in Eastern Europe, and new tariffs that threaten to disrupt global trade. All those events caused the market to enter a tailspin, but each time it recovered just as fast.

Those extreme recoveries were fertile ground for speculation, as they represent the unlikely positive outcomes that sit at the far right-hand side of Vanguard S&P 500 ETF’s bell curve. They created an environment for immense wealth creation.

Smart investors have used those opportunities to put money to work in low-cost, well-diversified ETFs that will hold up well over the long run. Speculators likely recognized the opportunity as well, but they selected ETFs that amplify risk, hoping to make a quick buck.

It’s fair to acknowledge that some people have experienced tremendous success with stocks and ETFs over the past several years. There are a lot of stories in various media outlets about big bets leading to life-changing money. But luck played a big role in their fortune. They were in the right place at the right time, and their stories should not be used to justify speculation. Far fewer stories are written of speculators losing it all.

Silver Linings

Asset management has come a long way since Lefèvre published his book more than 100 years ago. There are better tools available today to invest in the market, including pooling money in mutual funds or ETFs, thereby diversifying risks, and reducing fees and trading costs. All shift the odds in an investor’s favor and contribute to the long-term success of their investments.

The current state of the ETF market is not all doom and gloom. Two big positive trends have emerged over the past several years. The first is overall inflows into low-cost broadly diversified ETFs such as Vanguard S&P 500 ETF, Vanguard Total Stock Market ETF VTI

, iShares Core S&P 500 ETF IVV, and others like them. They continue to take in more money than just about any other ETFs out there, often billions of dollars every month.

The table below lists the leaderboard for 2025 through the end of December. Those at the top of the list are great long-term holdings that should stand the test of time.

Broad ETFs Win Flows

The second trend, and somewhat related to that first point, is a large group of investors who appear to be making smarter long-term investments, regardless of what the market does on any given day, week, or month. Flows into ETFs tracking the broader stock market have been immensely sticky since early 2020, despite the market’s ups and downs. That’s a huge win.

In many ways, the ETFs at the top of the table are the antidote for the casino culture that has flourished over the past several years. The only persistent winner in a casino is the house. Why not just buy and hold the house?