Exchange-Traded Funds: ETF Investment Strategies
ETFs provide considerable flexibility in implementing various investment strategies or building investment portfolios. Strategies range from very simple, such as diversifying an existing portfolio, to sophisticated hedging strategies.
An investor can consider using a few ETFs as core portfolio holdings. A low-cost diversified portfolio can easily be constructed with a few ETFs to cover the major equity asset classes and the fixed-income market. From that starting point, the investor can customize a portfolio with additional securities, mutual funds or other ETFs. (To learn more, read 10 Reasons To Make ETFs The Core Of Your Portfolio.)
An investor can take a passive approach to asset allocation by rebalancing the portfolio only to ensure it returns back to the long-term or strategic asset mix. Alternatively, the investor can take an active role in asset allocation, by tactically rebalancing the portfolio, overweighting those asset classes that are expected to outperform in the shorter term and underweighting the others. (For more on strategies, read Asset Allocation Strategies.)
ETFs allow the investor not only to diversify across all the major asset classes, such as U.S. equity , foreign equity and fixed income, but also to diversify into investments that have a low correlation to the major asset classes. This includes areas like commodities, real estate, emerging markets, small cap stocks, and others. (For more insight, read Introduction To Diversification.)
The use of ETFs allows for a variety of hedging strategies. Investors who want to hedge against a drop in the market can purchase inverse ETFs or leveraged inverse ETFs, which rise when the market falls. An investor concerned about inflation can hedge it by investing in commodities or inflation-protected bond ETFs. Investors that have investments out side the U.S. can hedge their foreign currency exposure with currency ETFs. Of course, investors can short an appropriate ETF that can hedge against a very specific stock market exposure. Many ETFs have options that can be used for other hedging strategies, either separately or in conjunction with the underlying ETF. (To learn more, check out A Beginner's Guide To Hedging.)
ETFs can be used to "equitize" cash, allowing investors an easy way to put their money in the stock market until a long-term investment decision is made. In this way, investors can ensure they do not miss out on price rises or forego income while their money is parked temporarily.
Tax-loss harvesting is a strategy of realizing capital losses in a taxable account, and then redeploying the sale proceeds among similar investments, leaving the investor's portfolio largely unchanged. The wash-sale rule prevents an investor from selling a security at a loss and then immediately repurchasing it by disallowing the purchase of "substantially identical" securities within 30 days of a sale. With the availability of a wide variety of ETFs, buying an ETF that is very similar to the fund or stock being sold is easy. The end result is a portfolio that closely resembles the one before the capital losses were realized without invoking the wash-sale rule. (For more on this strategy, see Selling Losing Securities For A Tax Advantage.)
An investor might want to quickly gain exposure to specific sectors, styles or asset classes without having to obtain the prerequisite expertise in these areas. As an example, an investor who has no expertise in emerging markets can buy an ETF based on an emerging market index. Using ETFs allows an investor to easily fill the "holes" in his or her portfolio.
Many investors move portfolio assets between different advisors, managers or funds. In the transition period, the assets might be allowed to sit idle in cash. ETFs allow investors to keep their assets invested rather than having them dormant.
Alpha is used in finance to represent two things: 1. a measure ...
Equity is the value of an asset less the value of all liabilities ...
A security that tracks an index, a commodity or a basket of assets ...
A securities license entitling the holder to register as a limited ...
Investopedia explains the definition of exchange-traded mutual ...
A distribution of a portion of a company's earnings, decided ...
The appropriate benchmarks for tracking banking sector performance depend on the type of banking. For instance, commercial-only ... Read Full Answer >>
The Nasdaq became the world's first electronic stock exchange at its inception in 1971. The exchange's dedication to advancing ... Read Full Answer >>
The creation and structure of exchange-traded funds (ETFs) are similar to that of mutual funds. An ETF serves as a portfolio ... Read Full Answer >>
The financial services sector, made up of investment brokerage houses, credit services companies and asset management firms, ... Read Full Answer >>
In a consumer economy fueled by credit, a natural place to look for a lucrative investment opportunity is with credit card ... Read Full Answer >>
The utilities sector has long been a space for investors looking for dividend-paying investments, especially in a lower interest ... Read Full Answer >>
The three most common exchange-traded funds, or ETFs, that track the oil & gas drilling sector are the SPDR S&P Oil ... Read Full Answer >>