ETF Investment Strategies
Exchange traded funds provide considerable flexibility in implementing several different investment strategies or building investment portfolios. Strategies range from very simple, like diversifying an existing portfolio, to various sophisticated hedging strategies.
Core Holding
An investor can consider using some ETFs as core portfolio holdings. A low-cost diversified portfolio can be easily constructed with help of a few ETFs for covering the major equity asset classes and fixed-income market. The investor can customize a portfolio with the help of additional securities, mutual funds or other ETFs.
Asset Allocation
With ETFs, creating a portfolio for any asset allocation strategy is quite simple. It is even possible to purchase an ETF that is already diversified across many different asset classes.
An investor can take a passive approach for asset allocation by rebalancing the portfolio just to ensure it returns back to the long-term or strategic asset mix. Otherwise, the investor can take an active role in the asset allocation process, by tactically rebalancing the portfolio, overweighting those asset classes which are expected to outperform in shorter term and by underweighting the others.
Diversification
ETFs provide an option to the investor not only to diversify across several major asset classes, such as foreign equity, U.S. equity, or fixed income, but also to diversify into investments that have a low correlation to the major asset classes. This includes areas such as commodities, emerging markets, small cap stocks, real estate, and others.
Hedging
Investors who want to hedge against a drop in the market can purchase inverse ETFs or leveraged inverse ETFs that rise when the market falls. Investors concerned about inflation can also hedge against it by investing in commodities or inflation-protected bond ETFs. Many ETFs also have options that can be used for various other hedging strategies, either separately or in conjunction with the underlying ETF.
Cash Management
ETFs can also be used to "equitize" cash, allowing investors to put their money in the stock market till the time a long-term investment decision is made. This way, investors can ensure that they do not miss out on price rises or forego income when their money is parked temporarily.
Tax-Loss Harvesting
Tax-loss harvesting is a strategy in which capital losses are realized in a taxable account, and then redeploying sale proceeds among similar investments, leaving the investor's portfolio principally unchanged. The wash-sale rule prevents an investor from selling security at a loss and then immediately repurchasing it by not allowing the purchase of "substantially identical" securities within a period of 30 days of a sale. With the availability of a wide variety of ETFs, buying an ETF that is identical to the fund or stock being sold is very easy. The end result is a portfolio that strongly resembles the one before the capital losses were realized without invoking wash-sale rule.
Completion Strategies
An investor may want to quickly gain exposure to specific sectors, asset classes or styles without having any expertise in these areas. As an example, an investor who has absolutely no expertise in emerging markets can buy an ETF depending on an emerging market index.
Portfolio Transitions
Many investors shift portfolio assets between different advisors, managers or funds. In this transition period, the assets might be allowed to sit idle. ETFs allow investors to keep their assets invested rather than having them idle / dormant.
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