The advantages of investing in ETF portfolios are real and the reason for growing popularity of using ETF shares as an investment strategy. ETF portfolios benefit asset allocation investing because they increase diversification, provide the ability to target specific investment segments, and, through exotic ETFs, allow an investor to hedge their portfolio with relatively low risk.
ETF Asset Allocation
Asset allocation is the process of dividing your assets among different asset classes (i.e. stocks, bonds, cash, etc.). Once you have determined your asset allocation there is a wide variety of ETFs available to help you meet any asset allocation target you have. ETFs can help a portfolio manager lower risk without lowering returns, or increase returns without increasing risk. This can be accomplished because of the following ETF attributes:
Increases Diversification – ETFs provide instant diversification when circumstances call for a basket of stocks (see ETF Investing Disadvantages). Diversification means owning enough individual investments within an asset class or category (ie. stocks, foreign stocks, bonds, real estate, etc.) to minimize your specific or unsystematic risk. Several factors, including how large your allocation is to the asset class, might determine whether you use ETFs or individual stocks.
Can Target Specific Investment Segments – Asset allocation management is made easier by ETFs because of the wide variety of choices available. For the U.S domestic investor the choices are almost limitless. This allows a portfolio manager to diversify into specific market niches or sectors with a small but diversified position. For example, let’s say an investor believes investing in water is a good investment. Yes, there are several water ETFs to choose from. Almost any sector imaginable is now available in an ETF portfolio.
Internationally the choices are almost as good. Investing in individual international stocks may be more risky; particularly in small, emerging, and frontier markets. ETFs provide instant low cost diversification in diverse categories such as emerging and frontier markets, foreign large cap dividend growth, small-cap country funds, sector funds, etc. These are just examples of literally hundreds of international options.
Inverse ETFs Can Be Low Risk Hedging Vehicles – Hedging is a potent risk diversification strategy employed by purchasing an investment that is correlated inversely to other assets in a portfolio. An Inverse ETF is programed to move the opposite direction of a specific index. Inverse ETFs allow a portfolio manager to take the market risk partially or wholly out of an entire portfolio or specific segment of a portfolio.
Investing With ETF Portfolios
ETF portfolios are a valuable tool for asset allocation investing. A portfolio manager should take advantage of the benefits of ETFs; increased diversification, the ability to target specific investment segments, and the opportunity to lower portfolio risk with low cost hedges. Used wisely, ETF portfolios can lower risk and/or improve portfolio returns.
Related Reading:
These Are the Reasons You Should Invest in ETFs
Inverse ETFs Provide Portfolio Hedging Strategies
| AAAMP Blog by Ken Faulkenberry | |
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Ken Faulkenberry earned an MBA from the University of Southern California (USC) Marshall School of Business with an emphasis in investments. Ken has 25 years of investment experience and is dedicated to helping people with self-directed investment management through the Arbor Investment Planner. His asset allocation strategies have an outstanding performance record. |
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