How to Use ETFs in a Portfolio

As the ETF industry has exploded in size, so too have the ways that investors use these flexible funds to address critical portfolio needs.

Managing Your Portfolio with ETFs

Investors of all types and sizes are employing diverse strategies to construct and manage portfolios using ETFs:

Broaden Asset Allocation

ETFs offer investors a sophisticated tool to gain exposure to broad and targeted market segments covering a wide range of asset classes, equity market capitalisations, styles, and sectors. This enables investors to build customised investment portfolios consistent with their financial needs, risk tolerance, and investment horizon.

Strategic Asset Allocation

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

Tactical asset allocation is a short-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.

Core-Satellite Strategies

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 additional return 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.

Access Hard-to-Reach Markets

ETFs have democratised investing, giving individual investors the same access to investment solutions as for larger institutional investors — at the same price.

The ETF wrapper has opened up new doors to:

• Emerging markets
• Fixed income
• Commodities
• Currencies
• Managed portfolios
• And many more

ETFs offer expanded market exposures in a convenient, portable investment instrument.

Portfolio Management

There are a number of portfolio management options using ETFs:

• ETFs are a helpful tool for rebalancing portfolios and keeping them on track to meet long-term strategic asset allocation targets.
• ETFs can easily be used to refine portfolio strategy and adjust exposures in response to shifting market conditions or an investor's changing needs.
• Financial year-end can be an apt opportunity to rebalance portfolios while taking advantage of possible unrealised losses.

Risk Management

The broad array of ETFs available today creates risk management approaches for individuals and smaller institutions that only large institutional investors could access previously.

For example, sector ETFs can also be a useful tool for investors, allowing them to hedge their individual stock investments by effectively diversifying their risk exposure across the broader equity market.

Tax Management

ETFs can be easily employed to help investors minimise their tax consequences. Because ETFs usually track market indexes, turnover is generally low. Typically, lower turnover results in fewer capital gains and thus lower taxes. Investors typically don’t realise capital gains from other unitholder redemptions.

How ETFs May Benefit Your Overall Portfolio

ETFs offer several benefits that can enhance the overall performance of your portfolio, including:

Diversification and Flexibility

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 specialised investment strategies, such as low-volatility or thematic investing, which gives investors the ability to tailor their portfolios to their specific investment goals.

Lower Management Costs

Because most ETFs are passively managed, they typically have lower management fees and operating expenses compared to managed funds. Additionally, ETFs are easy to trade and can be bought or sold on an exchange just like a share, making them a convenient option for investors who want to buy or sell positions quickly.

Increased Transparency

ETFs offer greater transparency compared to other investment options. ETFs generally disclose their holdings on a daily basis, allowing investors to see exactly what they are investing in and how their investments are performing.

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 healthcare, 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 broad market bond, high-yield bond, or emerging debt ETF.
• If you’re looking for exposure to real estate, a REIT ETF may be a good option.

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.

What Should My ETF Portfolio Look Like?

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.

How Many ETFs Should be in a Portfolio?

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.

There’s Plenty More to Learn About ETFs

Visit our ETF Education Hub to explore other ETF topics.