Incorporating ETFs into an Investment Strategy
Why add ETFs to a portfolio?
ETFs offer several benefits to investors:
| Accessibility: | ETFs lower the barriers to participation in almost every market and asset class. This is especially the case in areas historically restricted to institutional investors, such as commodities, real estate, and certain areas of fixed income. |
| Diversification: | ETFs can help reduce concentration risk by investing in a broader basket of asset classes, indexes, and sectors that may thrive under different economic conditions. |
| Low-cost: | Fees for investing in ETFs can potentially be lower than those for mutual funds or trading individual securities. |
| Expertise: | By investing in an ETF, you can gain access to established index exposures and actively managed portfolios. |
Establishing an ETF Strategy
Whether you are a first-time ETF investor or are seeking to complement an existing portfolio with new investments, the breadth and flexibility of the ETF universe means it’s possible to make them the core of a balanced, well-diversified strategy or use them to fine-tune an existing plan.
First Step: Investment Objectives
The first task is assessing your individual goals and investment horizon. Are you seeking a short-term liquidity boost, regular income, or long-term capital appreciation for retirement or legacy planning? Most investors will have a mix of goals and priorities that change as they move through life.
Consider what level of risk you are ready to accept. Do you have a pool of savings that you want to preserve and grow modestly over time, or are you willing to see your investments potentially rise and fall significantly in pursuit of higher long-term returns?
Second Step: Portfolio Building
Setting your goals and time horizon gives you the clarity necessary to build a portfolio that meets your needs.
A core portfolio of broad equity ETFs for growth combined with high quality bond ETFs for more defensive positioning could be an excellent place to start. Depending on your risk tolerance and/or return expectations, the sizing of the growth relative to defensive allocation may vary. With the core portfolio forming a solid investment foundation, you can also layer other ETFs to suit.
For example, you might add an investment-grade bond ETF or a dividend-focused equity ETF for a steady income stream. For potentially higher returns (and more risk), you might look at an ETF that invests in high-yield bonds, or emerging-market equities or debt. You could add an ETF built around the growth factor or sector-specific stocks for a more targeted strategy.
As a general rule, ETFs focused on stocks, real estate, and infrastructure will raise the risk-return profile of your portfolio. At the same time, fixed income has historically acted as a ballast, complementing and balancing a portfolio’s exposure to risk.
The flexibility of ETFs enables investors to adjust the balance between risk and expected return as their needs and risk appetite change.
Third Step: Entry Point
When choosing an entry point, you could consider a lump sum investment or allocate regularly with smaller amounts. A lump-sum investment means that your money starts to work immediately, whereas investing in instalments (known as “dollar-cost averaging”) lessens anxiety about picking the “right time” to invest and, in theory, enables investors to buy the market at an average price. Both approaches have their pluses and minuses, and the route investors choose will depend on factors such as their risk tolerance and investment timeframe.
A world of opportunity
Historically, ETF investments have been heavily focused on developed markets, but emerging markets are playing a growing role. Economic cycles in emerging markets are often different to those in the developed world, so adding exposure to the world’s burgeoning economies allows investors to more fully capture opportunities across the globe.