How to use ETFs in your portfolio: Steps and strategies

• ETFs offer many benefits including their inherent diversification, flexibility, low costs, transparency, and tax efficiency. 
• When constructing a portfolio with ETFs, it’s important to consider your investment goals, risk tolerance, and overall investment strategy.
• You can use ETF strategies to build a core portfolio, make short-term market moves, manage risk, and keep your tax bill low.

Back in 1993, paper maps guided your trips, phones had cords, and something ‘online’ usually meant drying laundry. That year also marked the launch of the first US-listed ETF, which has since exploded into an $18 trillion global market.¹ Ready to put this popular type of investment to work for you?

Why use ETFs in your portfolio?

Today’s technology lets you invest in just about anything—from personalized sneakers and future whiskey casks, to virtual gaming items and digital art. But most investors generally still rely on stocks, bonds, mutual funds, and ETFs to build the core of their portfolio.

ETFs are a popular choice because they’re simple, flexible, and cost effective. They offer several advantages:

• Easy diversification: One ETF can hold dozens—even hundreds—of stocks or bonds, so you’re not relying on just one investment as your only ticket to build your wealth over time.
• Lower costs: Because most ETFs are passively managed, they typically have lower management fees and operating expenses compared to mutual funds. 
• Portfolio transparency: ETFs’ daily disclosure of underlying investments gives you clear visibility into what you own.
• Wide range of choices: With more than 14,000 ETFs globally² —covering everything from broad global indexes to specialized industry niches—there’s a strategy to suit nearly every investor.
• All-day trading: Unlike mutual funds, which trade only once per day, ETFs can be bought or sold anytime the market is open.
• Efficient tax management: The structure of ETFs helps minimize capital gains taxes and they can also be used in the tax-loss harvesting process.

No investment vehicle is risk-free. It’s important to consider potential risks before investing. Some ETFs trade less actively, making them more difficult (and potentially more expensive) to buy or sell. Also, an ETF’s performance might not perfectly match the index it tracks. And, like any investment vehicle, ETFs can shut down if they don’t attract enough assets.

A simple blueprint for adding ETFs to your portfolio

Save your impulse buys for novelty socks and scented candles. When buying ETFs, you want a rock-solid plan so you make the best choices for your goals. Here are steps you can take to add ETFs to your portfolio the smart way.

1. Define your goals

The first step is thinking through what you’re investing for, whether it’s retirement, your child’s college tuition, or buying a home. Understanding your goals helps set appropriate timelines. If a goal is further in the future (let’s say 20-30 years), you can usually be more aggressive with your ETF investments because there’s time to recover from market downturns.

2. Assess your risk tolerance

How do you feel when your investments take a dip? Typically, more risk in the short run equates to higher potential returns in the long run. But that only works if you have the stomach to stay invested through the ups and the downs. Knowing your comfort level helps prevent panic selling that might derail your goals during market swings.

3. Build your portfolio mix

Determine the right balance of stocks, bonds, and other assets for your goals and risk tolerance. A diversified mix helps manage risk while giving your portfolio growth potential. Here are sample portfolios aligned to different levels of risk:

4. Choose your ETFs

Time to go shopping! Choose ETFs that fit the categories you’ve set for your portfolio. As you compare, pay attention to costs, what each fund invests in, and how closely it follows its index (if it has one). State Street Investment Management offers a wide range of ETFs to choose from.

5. Review and refine

It’s a smart idea to set regular check-ins to see if your portfolio is still on track with your goals. During these reviews, you can add any extra money you’ve saved and make sure your ETFs are performing as expected. Over time, some investments may grow faster than others, so you may need to sell a portion to rebalance your portfolio and keep it aligned with your original strategy.

ETF strategies to power your portfolio

There are lots of ways to put ETFs to work. The right approach can help you keep your portfolio balanced, handle risk, and adjust as the market changes. Understanding the strategies below gives you more control over how your investments grow.

Strategic asset allocation

Strategic asset allocation is simply putting a plan in place for a long period of time. The goal is expected to remain the same so you can focus on keeping the portfolio in line with the original plan. As some investments grow at different rates, rebalancing (or, buying and selling to keep things aligned) may be necessary. By focusing on your overall risk and long-term goals, you can stay on track without reacting to every market swing.

Whether you want broad exposure to global stocks, bonds, or specific market exposure, there’s likely an ETF—or combination of ETFs—that can help you get there.

Tactical asset allocation

Tactical asset allocation is all about making short- to medium-term adjustments to your portfolio to take advantage of opportunities in the market. For example, you might put a little more into sectors or markets that look promising and scale back in areas that seem less attractive.

You can also easily reverse these moves when things change. ETFs are a great tool for this because they trade throughout the day and usually come with lower costs, making it simple to tweak your portfolio as needed.

Core-satellite

A core-satellite strategy seeks to provide investors with both stability and opportunity. You use broad market-based ETFs in the core of the portfolio for steadier exposure to the overall market. Then, you add satellite investments, like sector, commodity, actively managed, or other specialized ETFs, to target areas that could outperform or provide additional diversification. With this approach, you can aim for higher returns while keeping risk under control and your diversification intact.

Risk management

Investors focused on managing risk can use ETFs to get instant diversification to hundreds of stocks and bonds in a single trade. With ETFs available for almost every sector, region, and strategy, you can mix and match—giving you diversification that was once only available to investment professionals and large institutions.

For a more advanced risk strategy, some investors who own a lot of stock in a single company use ETFs to sell short, which means betting against certain markets or sectors to protect their portfolio if prices fall.

Tax management

ETFs can be surprisingly handy when it comes to managing taxes. Because of the way they’re structured, buying and selling ETF shares often triggers fewer capital gains taxes than trading individual stocks or mutual funds. This means you might owe less in taxes on your investment gains each year.

You can also use ETFs for a strategy called tax-loss harvesting. Selling shares that have dropped in value to realize a loss can offset gains elsewhere in your portfolio to lower your overall tax bill.

Keep in mind that the Internal Revenue Service’s Wash-Sale Rule prohibits claiming a loss on the sale of an investment if the same or “substantially identical” investment is purchased either 30 days before or after the sale date. But you can use another ETF as a “tax swap” to serve as a placeholder to maintain exposure to the asset class for 30 days. After 30 days, you can decide whether to switch back to the original ETF.

Factors to consider when constructing your portfolio

The types of ETFs in your portfolio will depend on your investment goals and risk tolerance. For example:

• If you are looking for exposure to a broad range of assets: You may consider adding a broad-market ETF to your portfolio, such as an S&P 500 ETF or a total stock market ETF. 
• If you are looking for exposure to specific sectors: Such as Technology or Health Care, you may consider adding sector-specific ETFs to your portfolio.
• If you are looking for exposure to bonds: You may consider adding a bond ETF to your portfolio, such as a total bond market ETF or a high-yield bond ETF. 
• If you’re looking for exposure to real assets like real estate: A REIT ETF may be a good option.
• If you’re looking for exposure to new disruptive technologies like blockchain and AI: A digital asset ETF may be right for you.

It’s important to remember that diversification is key to reducing risk in a portfolio. By including a mix of ETF types and asset classes, you can diversify your holdings and potentially reduce your overall portfolio risk.

Ready to get started? It’s easy with ETFs

Building a portfolio with ETFs makes investing simpler and more flexible. You can mix and match different ETFs to spread out risk, target specific sectors or markets, and even manage taxes along the way. By picking the right combination and checking in on your portfolio regularly, you can stay on track with your goals and take advantage of market opportunities without losing sleep over every market swing.

Bottom line, building a portfolio with ETFs provides a flexible, cost-effective, and accessible way to pursue your goals.