Exchange Traded Funds (ETFs) are very much like mutual funds but are also different since they are exchange-traded throughout the day, giving intraday liquidity for investors. Unlike MFs, the ETFs trade on exchanges, so investors can short them and buy or sell options on them. It is the flexibility and transparency of ETFs that make them more attractive to investors than the portfolio of mutual funds. Exchange traded funds (ETFs) generally provide excellent diversification at low expenses. It allows investors to fill the gap in an investment portfolio. So, what people do? They mix the ETFs with mutual funds, stocks, and bonds in their accounts.
But, have you ever consider building a portfolio out of nothing but ETFs?
You must be wondering if it makes any sense!
Well, truth to be told ‘Yes’.
The emergence of the ETFs has been really great for investors, as low-cost expenses are now available in the asset class in the market. Nowadays many investors prefer to invest in ETFs instead of stocks for two basic reasons –
1. Instant Diversification
2. No Company-specific risk
In this article, our goal is to help you in grasping some basic knowledge of ETFs and how to build your own all-ETF portfolio.
But, before you create an all-ETF portfolio, you need to learn how to choose the right ETFs.
How to Choose the Right ETFs?
When looking for the best exchange-traded funds for your portfolio, the very first thing you need to consider is the composition of the ETF. It is because most of ETFs are made up of water-related stocks but when the top holdings analyzed, you will find out that they vary with the niche sector. So, one may be composed of water utilities another may have infrastructure stocks as the top holdings.
Next is to gauge the ETF performance. But, not blindly judge an ETF’s future performance based on its past performance. Apart from this, you can give some thoughts to the assets under management, daily average volume, and bid/ask spread.
How to Build an ETF Portfolio?
If you are planning to build an ETF portfolio then you need to give special attention to few things and follow some guidelines as are –
Step 1: Pick the Right Allocation
When building a portfolio with ETFs, one must look at the objective of the portfolio. Whether it is for a retirement plan or saving for child education. Plus, you also need to consider your time horizon, return and risks expectations, and distribution needs. Because if you have income needs, you will have to add fixed-income ETFs or equity ETFs that pays dividends. Also, don’t forget to check for your legal and personal situations, and more importantly, what’s the role of the portfolio in your overall investment strategy to determine your asset allocation?
You can also go through the 3-factor model in evaluating market returns.
• Equities have more risk than bonds so equities should outperform bonds over time.
• Value stocks should outperform growth stocks over time because they inherent more risks.
• Small-cap stocks outperform large-cap stocks over time because they have a more undiversifiable risk than large-caps.
Note: – Do not try to time the market. If anything history and research studies taught us is that “timing the market is not a winning strategy”. Majority of returns depend upon the allocation rather than timing.
Step 2: Implement your Strategy
It is the biggest advantage of exchange-traded funds is that one can select ETF for each sector or index in which one wants exposure. In this way, you can analyze the available funds and decide which one will best meet your allocation needs.
However, there are certain things you should avoid at any cost. For example,
• Placing all buy orders in one day
• Placing stop-loss more than 20 percent below the original entry price
• Not moving up stop-loss as the ETF gains in price
Step 3: Performance Monitoring
Now that you are all set up by creating an ETF portfolio, it is time to check for the performance of ETF portfolio. The beginning and end of the year are considered idle time for doing this. One can track error in comparing each ETF’s performance to that of its benchmark index. If you found any, replace that fund with one that will invest truer to its stated style.
Note: – Do not overtrade.
Creating an All-ETF Portfolio
In making a portfolio solely of ETFs, make sure to add multiple classes to create diversification.
1. Sector ETFs – It would be wise to choose ETFs from different sectors that are largely uncorrelated. And to take that decision one must consider fundamentals, technicals, and economic outlook.
2. International ETFs – that covers all regions from developed markets to emerging markets. Similar to the sector ETFs, the choice should be based on fundamentals and technicals.
3. Commodity ETFs – are quite an important part of an investor’s portfolio. Everything from gold to oil to cotton can be tracked with ETFs. But, try not to track individual commodities since they can be extremely volatile.
Final Thoughts: –
If one thing anyone knows about the stock market is that “There will be ups and downs no matter what”. So, building a low-cost all-ETF portfolio should ease volatility and help in achieving the investment goals.
Note: All information & data provided in this article is for the educational purpose as well as to give general information on the finance & economy, not to provide any professional advice or service. Views & opinions are not biased against the company and do not affect any official policy or any other agency, an organization within the content.