One of the investing trends of recent years is the rise in popularity of the exchange traded fund (ETF). ETFs are constructed like funds in that they contain a collection of investments, but they trade like stocks. So, it’s easy to buy and sell ETFs on the stock market. You pay a transaction fee, and, because ETFs are funds, you do have a small administrative fee. However, those fees are usually low; it’s not hard to find ETFs with annual fees of between 0.35% and 0.75%.

Some investors worry, though, that adding ETFs could upset the asset allocation in an investment portfolio. Others, though, recognize that it’s possible to construct a diversified portfolio using nothing but ETFs. This is because ETFs aren’t limited only to stocks.

Creating a Portfolio Using ETFs

ETFs are collections of different investments. This means that there are stock ETFs and bond ETFs. For someone looking to create a portfolio with a traditional asset allocation of stocks and bonds, this is fairly straightforward. You determine your asset allocation, and the purchase the appropriate stock or bond ETFs.

It’s even possible to add even more diversity to your investment portfolio with ETFs. There are real estate ETFs, commodity ETFs, and currency ETFs. All of these ETFs allow you to broaden your investment horizons. You can invest in real estate without the large amount of capital needed to buy property. You can invest in commodities without having to deal directly with futures contracts. You can even diversify, since there are a number of foreign ETFs that help you invest in ways that are geographically diverse. And, if you are looking for income, there are income ETFs that focus on a mix of dividend paying stocks and bonds. There are also riskier options like leveraged ETFs.

For many people, the ease of ETFs makes it possible to create the kind of portfolio they’ve always wanted, but didn’t have the capital, or the knowledge, to make before.

Choosing Your Investments Carefully

Even though the use of ETFs can reduce some of your investment risk, it’s important to recognize the fact that you are still investing, and that there is still the chance of loss. Indeed, you can lose money investing in ETFs, even with the diversity that there is. And it’s always a good idea to at least have a general idea of how the underlying investments in an ETF work. If you’re going to invest in a currency ETF, it’s usually a good idea to have some knowledge of how forex trading works, and what factors impact the currency market. Make sure you aren’t just adding ETFs to your portfolio because you think something “sounds good.”

Any time you build a portfolio, you need to carefully consider your needs, and figure out what is likely to help you reach your goals. ETFs can be great for building a portfolio with the asset allocation you need to reach your goals and grow your wealth. However, you will need to do your due diligence, and research the situation in order to make sure that you are taking proper precautions against loss.

Tom Drake
Tom Drake

Tom Drake writes for Financial Highway and MapleMoney. Whenever he’s not working on his online endeavors, he’s either doing his “real job” as a financial analyst or spending time with his two boys.