ETFs were originally conceived to help provide pricing transparency for institutional investors. But as the industry has exploded in size, so too have the ways that investors use these flexible funds to address critical portfolio needs.
Investors of all types and sizes are employing diverse strategies to construct and manage portfolios using ETFs:
ETFs offer investors a sophisticated tool to gain exposure to broad and targeted market segments covering a wide range of asset classes, equity market capitalizations, styles, and sectors. This enables investors to build or tailor customized investment portfolios consistent with their financial needs, risk tolerance, and investment horizon.
Strategic asset allocation is a target allocation of asset classes you expect to have in place for a long period of time. The target allocation is expected to remain the same and the portfolio is rebalanced to the original allocations when they deviate significantly from the initial settings due to differing returns from the various assets. Strategic asset allocation looks more at the overall risk objective of the portfolio, and therefore takes a long-term view.
Whether you’re looking to cover the broad global equity market, the total bond market, or take positions in specific countries, commodities or real estate, there’s likely an ETF — or ETFs — to help meet your objectives.
Tactical asset allocation is a short- to intermediate-term view that looks for investment opportunities in the market. It allows investors to make real-time adjustments to their long-term asset allocation to take advantage of short-term tactical opportunities.
Tactical adjustments might include increasing allocations to markets and sectors that have become more attractive or decreasing exposures to less attractive ones. Investors can also easily reverse these tactical moves once the opportunities and risks have run their course. ETFs are an efficient tactical asset allocation tool as they offer intra-day trading at typically lower costs.
A core-satellite strategy seeks to replicate the broad market return in the core portion of a portfolio, and uses a satellite strategy to find alpha opportunities and add diversification using non-core market exposures.
Broad, market-based ETFs can be used as the core of an investment strategy. Sector, commodity-based, or other smart beta or active ETFs can be used to add a cost-effective satellite strategy to a portfolio to complement the core. This approach allows an investor to customize their exposure and risk to potentially enhance returns.
ETFs have democratized investing, giving individual investors the same access to investment solutions as institutional investors — at the same price. The ETF wrapper has opened new doors to:
ETFs offer expanded market exposures in a convenient, portable investment instrument.
There are several portfolio management options using ETFs:
The broad array of ETFs available today creates risk management approaches for individuals and smaller institutions that only large institutional investors could access previously.
ETFs can be easily employed to help investors minimize their tax consequences. ETFs are inherently tax efficient vehicles and can be used to harvest tax losses while potentially avoiding the impact of wash-sale rules.
When investors change asset managers, they’re often concerned with how to preserve equity exposure during the transition. One way to achieve this goal is to liquidate the portfolio and then re-invest the assets in an ETF with a high correlation to the benchmark of the active manager. Once a new manager is chosen, the investment professional can sell the ETF shares to fund the purchase of this exposure.
ETFs offer several benefits that can enhance the overall performance of your portfolio, including:
ETFs can provide broad or targeted exposure to a wide range of asset classes, such as equities, bonds, commodities, and real estate, allowing investors to diversify their portfolios with just a few trades. ETFs also offer access to specialized investment strategies, such as low-volatility or socially responsible investing, which gives investors the ability to tailor their portfolios to their specific investment goals.
Because most ETFs are passively managed, they typically have lower management fees and operating expenses compared to mutual funds. Additionally, ETFs are easy to trade and can be bought or sold on an exchange just like a stock, making them a convenient option for investors who want to buy or sell positions quickly.
ETFs offer greater transparency compared to other investment options. ETFs disclose their holdings on a daily basis, allowing investors to see exactly what they are investing in and how their investments are performing.
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The types of ETFs in your portfolio will depend on your investment goals and risk tolerance. For example:
It is 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 reduce your overall portfolio risk.
A diversified portfolio will look different for each investor based on individual risk tolerance and goals. But with ETFs, a simple diversified portfolio can be built using just a few broad exposure ETFs. A diversified portfolio could consist of the following:
These portfolios offer exposure to a mix of different asset classes and investment strategies, allowing for diversification and reducing overall portfolio risks.
There is no one-size-fits-all when considering the number of ETFs in a portfolio, and will likely depend on the investor's investment goals, risk tolerance, and overall investment strategy. But as a general rule, some investors may choose to have a few ETFs in their portfolio to achieve basic diversification, while others may have a more extensive portfolio with a larger number of ETFs to achieve a higher level of diversification and target specific investment goals.
It is also important to consider each ETF’s underlying holdings and how they fit into the overall portfolio strategy. A well-diversified portfolio should include a mix of different types of ETFs and asset classes to reduce risk and achieve a balanced investment portfolio.
S&P 500 Index
The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the US stock market. The index is heavily weighted towards stocks with large market capitalizations and represents approximately two-thirds of the total market value of all domestic common stocks. The S&P 500 Index figures do not reflect any fees.
Sold Short or to Sell Short
Selling a security that is not owned by the seller, or that the seller has borrowed.
Investing involves risk including the risk of loss of principal.
The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA’s express written consent.
Diversification does not ensure a profit or guarantee against loss.
Equity securities may fluctuate in value and can decline significantly in response to the activities of individual companies and general market and economic conditions.
Bonds generally present less short-term risk and volatility than stocks, but contain interest rate risk (as interest rates raise, bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.
Because of their narrow focus, sector investing tends to be more volatile than investments that diversify across many sectors and companies.
Investing in REITs involves certain distinct risks in addition to those risks associated with investing in the real estate industry in general. Equity REITs may be affected by changes in the value of the underlying property owned by the REITs, while mortgage REITs may be affected by the quality of credit extended. REITs are subject to heavy cash flow dependency, default by borrowers and self-liquidation. REITs, especially mortgage REITs, are also subject to interest rate risk (i.e., as interest rates rise, the value of the REIT may decline).
Asset Allocation is a method of diversification which positions assets among major investment categories. Asset Allocation may be used in an effort to manage risk and enhance returns. It does not, however, guarantee a profit or protect against loss.
Frequent trading of ETFs could significantly increase commissions and other costs such that they may offset any savings from low fees or costs.
All information is from SSGA unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.