VanEck Rare Earth and Strategic Metals ETF Is Focused on a Hot Sector, Which is Good and Bad

Idiosyncratic risk is, basically, the risk associated with picking just one stock. There's no way to know exactly what could go wrong with one business. Which is why exchange-traded funds (ETFs) like VanEck Rare Earth and Strategic Metals ETF (NYSEMKT: REMX) exist.

Diversified ETFs let you buy a portfolio of stocks so you don't have to worry about the risk of owning just one company. But highly focused ETFs like VanEck Rare Earth and Strategic Metals ETF don't avoid all of the problems you may face. Here's why this rare-earth focused ETF is good and why many investors may still be better off avoiding it.

What does VanEck Rare Earth and Strategic Metals ETF do?

Without getting too deep into the details, VanEck Rare Earth and Strategic Metals ETF owns a collection of companies that produce rare-earth metals, just like its name implies. The portfolio lists 34 holdings, but some of those holdings are essentially cash. It owns a little under 30 stocks, including many foreign ones. The foreign holdings help explain the rather high expense ratio of 0.58%.

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That said, VanEck Rare Earth and Strategic Metals ETF allows investors to buy a basket of stocks in a highly focused investment niche. It is a good alternative for investors interested in rare-earth metals but don't want to dig in deep enough to buy an individual stock.

Diversification doesn't inherently make an ETF safe

The rare-earth story is pretty compelling, since these materials are vital to modern technology. Demand is expected to continue rising in the years ahead. This is why investors have been so hot on the sector, helping to push VanEck Rare Earth and Strategic Metals ETF's price up by over 125% in a year.

REMX data by YCharts

However, if you pull back further, you'll see that VanEck Rare Earth and Strategic Metals ETF has a history of being highly volatile. Rare-earth metals are commodities, and they behave like commodities, rising and falling with supply and demand. High commodity prices normally attract increased investment, leading to higher supply and lower prices. This is the long-term risk that investors should consider when buying a focused rare-earth metals investment.

VanEck Rare Earth and Strategic Metals ETF is doing very well right now. That may continue for a time. But if history is any guide, commodity markets eventually solve supply problems like the one that has investors pushing this ETF higher.

Make sure you consider the whole picture

VanEck Rare Earth and Strategic Metals ETF is a good way to invest in a basket of rare-earth metals stocks. But that only solves one of the problems you'll face if you decide to jump on the hot rare-earth metals investment trend. Most investors should tread with caution here.

Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.