10) Exchange-Traded Funds: ETF Investment Strategies

by · October 16, 2010

Flexibility is something ETFs are very good for when it comes to investment strategies and creating portfolios.

Core Holding

An ETF can be used as core portfolio holdings. With but a few ETFs, a low-cost and diversified portfolio covering the majority equity asset classes can be obtained. Later on the investor can choose to include bond ETFs, mutual funds and other securities into his portfolio.

Asset Allocation

ETFs that are diversified across different asset classes are already being offered. So, constructing a portfolio for any asset allocation strategy is easier now. The investor then only needs to rebalance the portfolio in a passive or active approach to ensure maximum profitability in the long run.

Diversification

Diversifying into investments even if its relationship to major asset classes is low is possible for ETFs. This would include areas such as real estate, small cap stocks or emerging markets.

Hedging

Hedging is an investment strategy that is used often in ETFs. Inverse ETFs or leveraged inverse ETFs, for example, can be used to hedge against a market decline and commodities or inflation protected bond ETFs, such as TIPS, are used to hedge against inflation. There are several other ETFs with options that can be used for other hedging strategies as well.

Cash Management

ETFs are a good place to park money temporarily while settling on a longer-term investment decision. This way, the investor is not missing out on any profits from the market instead of just having his money sit idly.

Tax-Loss Harvesting

Tax-loss harvesting involves realizing capital losses in a taxable account, and then reinvesting the proceeds of the sales. This strategy leaves the portfolio of the investor mostly intact.

A wash-sale rule stops an investor from selling securities at a loss then re-buying it immediately. The rule disallows buying “substantially identical” securities within a span of 30 days after the sale was made. With ETFs the investor can easily avoid the wash-sale rule and build a portfolio that nearly matches the one before the capital losses were incurred.

Completion Strategies

Even without enough expertise, ETFs still allow investors to invest on specific asset classes. In essence, the “gaps” in an investors portfolio can still be filled with this strategy.

Portfolio Transitions

Moving portfolio assets from one manager or advisor to another is common for investors and can take some time. This makes the invested money idle until the transition is done. This can be avoided using an ETF.