ETFs are a great, relatively new, financial instrument that opens new opportunities for investors. Using ETF investing strategies, it is possible to use them in ways that will greatly increase financial gains over time.
Those unfamiliar with ETFs can think of them somewhat like simplified mutual funds. Like mutual funds, they pool investor money together. Unlike mutual funds, the goal of an EFT is simply to follow a certain market or index. Because of this, they require far less management and therefore lower management fees. While there are various factors to consider when comparing ETFs vs. mutual funds, this is a very attractive feature for many. Although the differences in the fees taken by ETFs and mutual funds may not appear great, even a relatively small percentage can really add up over time. For a more detailed explanation of ETFs, see: what is an ETF.
ETF advantages in investing strategies
Every investment strategy must take taxes into account. Since ETFs can be bought and sold like stocks, most ETFs do not have taxable events until the investor sells them. This gives the investor much more control over when capital gains will be taken and thus makes it easier to build a tax strategy. Depending on the individual investor’s tax situation, taxable events can be created in years in which the taxpayer has a lower tax rate.
Strategies for the long or short term
Since they can be bought and sold like stocks quickly and have low minimum purchase requirements, a good ETF investing strategy can use them for short-term investments when cash reserves are temporarily higher. Money can be put into and taken out of the market at any time without incurring excessive fees while maintaining diversity. This makes them one of the best short term investments for those willing to take higher risks.
For long-term investments, the lower fees of ETFs can allow one’s investment to compound into something significantly greater than it would have been with higher fees. Of course, this is contingent on whether or not a more actively managed fund would have beaten the market average. Those investing in ETFs need to ask themselves if they are satisfied with the average market return of if they want to try to beat it.
Types of ETFs to consider
With so many different types available, anyone formulating an EFT investment strategy has to stop and consider which ones they want in their portfolio. Some of the most common include:
Market index ETFs: These are some of the most popular ETFs and are designed to track a certain market index. This is usually the best place to start for those new to ETF investing. Just about any index can be followed with an ETF.
Foreign and domestic: In an increasingly integrated world, it usually does not make sense to limit one’s investments to a single nation. Although they cannot remove the currency fluctuation factors that can affect the value of foreign stocks, they do make investing in them very easy.
Commodity ETFs: For those who want to diversify into commodity investing, ETFs offer what is probably the easiest way to do it. Putting money into commodities usually involves options that often make this kind of investing very volatile, but the risk is more manageable when done through commodity ETFs.
Foreign currency: Like commodity ETFs, these are very speculative. Always keep in mind that a profit from this type of investing only comes through the rise and fall of prices and currency and not through business returns.
Bond ETFs: On the other end of the spectrum, bond ETFs are some of the most stable, depending on the type of bonds they are invested in. Even though bonds are low liquidity, ETFs have found a way to buy and sell them like stocks.
Broad market or specific industry exposure
For most people not closely following markets, ETFs that follow broader indexes make better choices than narrower ones. However, the extensive selection of available ETFs makes it possible to tailor investments to specific industries. Those with specialized knowledge in or who are bullish on certain industries can make good use of industry specific ETFs in their investment strategies.
Active or passive investing
While ETFs can certainly be used for more passive, long-term investing, the ability to buy and sell them like stocks, a wide array of choices and fee structure make them attractive to more active investing. Particularly with the more speculative investments, ETFs offer a way to form an involved investment strategy that is impossible with mutual funds and not practical in a diversified way with individual stocks. Those wanting to go this path must keep informed and use their knowledge to try to buy and sell at optimal times.
ETFs and ETNs
ETNs (exchange traded notes) are a variation of ETFs. They are issued by providers as senior debt and not the securities, derivates commodities or whatever the type of ETF purchased represents. Similar to bonds, they are backed by a bank and are thus pretty secure but not without credit risk.
While ETF investing strategies will vary with the situation, the flexibility and diversity they offer make them a good option for most investors to consider.