Exchange Traded Funds (ETFs) can be used to diversify or complement a portfolio of other types of investment vehicles, such as stocks, bonds and/or mutual funds. It is also possible to build a diversified portfolio using only ETFs. In this article, we’ll discuss how one might go about building a portfolio of just ETFs to pursue specific investment outcomes.
Start at the Beginning
All investments are a means to an end. They can help people achieve their financial objectives. So, a helpful way to understand the utility of ETFs is to view them in the context of how investments generally get used by individual investors.
Different investments have specific characteristics. And there is a process to help align those characteristics with an individual’s unique desired outcomes or goals.
There are typically three steps in the process:
- Decide on an active or passive approach
- Determine your asset mix
- Pick specific ETFs
Decide on a Passive or Active Approach
There are two approaches to professional investment management, passive and active. Passive investing is intended to deliver returns that mimic the market by tracking a market index. Active investing seeks to deliver returns that outperform the market.
ETFs are available in both approaches. There are passive options and active opportunities.
In both cases, the term market or index may mean either stocks or bonds. And returns (from both passive and active approaches) would be net of any fees and expenses incurred to manage the fund. You can select one approach or combine them in a diversified portfolio.
For example, a passive approach may be suitable for the core of your portfolio. Active ETFs could then be added to achieve specific objectives, such as serving as a source of income or to gain exposure to a specific investment theme, such as investing in sustainable companies.
A distinction of active investing is that it lets investors pursue personal objectives that may not be available owning a broader market index.
Determine Your Asset mix
Once you’ve determined whether to pursue an active or passive approach, or a combination of both, the next step is to determine what mix of asset types will best help you achieve your goals.
People’s investment objectives are as unique as they are as individuals. Some seek long-term growth. Others want income. The mix of assets (e.g., stocks, bonds) in an ETF is intended to pursue various investment goals.
Determining an asset mix means divvying up money between different types (or classes) of investments. A portfolio ’s mix helps determine how it behaves, its likely risk and return and its propensity to deliver capital growth or income over time.
Mixing different asset classes together in various proportions may help shape a portfolio to stay within a desired risk tolerance, deliver intended results within a defined time frame or achieve a specific monetary goal. An easy way to achieve the appropriate asset mix might be by mixing together different ETFs.
ETFs might be used to pursue a given investment objective.
Pick Specific ETFs
So, how do you determine which ETFs to choose?
The universe of investments available through specific ETFs is very broad. An ETF exists for almost every type of imaginable investment objective. For example:
- Investors looking for accelerated dividend income growth might consider adding an ETF focused on companies that grow their dividends.
- Investors looking to reduce volatility in their portfolio might own an ETF that used a risk-weighted approach.
Exchange Traded Funds provide an extensive assortment of specific investment options. They are available in both passive and active versions. So, ETFs offer many options to help people build portfolios tailored to their unique circumstances.
Working with experienced financial professionals can help you stay the course. They can provide guidance and encouragement to help focus your attention on your long-term goals.