One of the investment choices growing in popularity recently is the exchange-traded fund (ETF).
Because ETFs are easy to trade, and come with low costs, they are fast becoming a staple of the investment scene. In fact, it’s possible to build a portfolio using only ETFs.
Types of ETFs
ETFs aren’t just about stocks. ETFs come in a number of asset classes. You can find ETFs comprised of:
It’s also possible to find ETFs that focus on different industries and sectors. There are ETFs that focus on real estate investments, as well as those that deal with emerging market bonds. You can diversify across industry and geography, as well as asset class, when you build a portfolio using ETFs.
No matter how you want to put your portfolio together, it’s possible to build it using nothing but ETFs.
Risk Tolerance and Asset Allocation
As you build your all-ETF portfolio, it’s important to consider the amount of risk in your portfolio, and how it relates to your ability to handle that risk. Just as you would with any other portfolio, you need to assess the amount of risk you can handle. If you think that your financial and emotional situation can handle a little more risk, adding currency and commodity ETFs might make sense. If you are more risk averse, it makes better sense to stick with stocks and bond ETFs.
You will also need to consider your asset allocation. For the most basic portfolios, asset allocation is often based on your age, and relies entirely on stocks and bonds. Look for a combination of solid stock and bond ETFs that can help you grow your wealth. As you get closer to retirement, you can sell some of your riskier stock ETFs, and replace them with bond ETFs, or with dividend ETFs that provide income.
Consider your investment goals, and how they evolve over time. There are ETFs that reflect a variety of opportunities, from foreign stocks to nothing but varying maturities of US Treasury securities.
Carefully think about how you want your portfolio to look if you weren’t using ETFs. Once you understand that, you can start looking for ETFs that fit your needs. The instant diversity of ETFs, and their low cost, can make them attractive, no matter your preferred asset allocation.
Consistency as You Invest
When using ETFs to build your portfolio, it’s important that you practice consistency in your efforts. Dollar cost averaging is an important part of building your all-ETF portfolio. Just as you can with regular stocks, it’s possible to buy partial shares of ETFs. This is helpful if you are interested in trying to branch out to currencies, real estate, and commodities. Being able to buy partial shares of an ETF based on those assets can help you increase your position fairly easily.
Come up with a plan, and then stick to it. Whether you hold ETFs in your retirement account, or whether you have them in a taxable account used for other purposes, consistency is key. Keep making regular investments over time, and your wealth is more likely to grow.
Understand the Underlying Investments
Don’t forget, though, that you need to stick with the fundamental rules of investing when you build an ETF portfolio. One of the most important rules is to understand what you are investing in. ETFs might make it easy to add currencies to your portfolio, but do you understand how the forex market works? Do you understand the risk of contango when you invest in commodity ETFs?
Before you branch out with your ETFs, take the time to understand the underlying investments. Even though you may not be investing directly in those assets, the way they perform affects your ETF. You should know how different assets react to different situations so that you have an idea of what to expect, and how to build your strategy.
Also, make sure you know what fees you are paying. For the most part, ETFs come with fairly low fees. But it’s not just the expense ratio you have to worry about; since ETFs trade as stocks, you will pay whatever transaction fee comes with the broker.
You can build an ETF portfolio, taking advantage of the ease and low cost ETFs offer. Just make sure you don’t forget the other rules of investing while you do it.