In this article we will discuss when you need to add ETFs to your portfolio, where to find them, and which ones to choose.
First of all, ETFs are exchange-traded funds or, simply put, a portfolio of compiled securities. It can consist of just stocks or just bonds, or a mix of the two.
You buy a share of this portfolio and it costs cheaper than if you buy all the securities individually. You can also trade precious metals (like gold), futures, options, and currencies.
If the price of securities within the fund rises, the price of your share rises.
When to buy ETFs?
There are 2 things that make ETFs special: diversification and cheapness. Since ETF is a compilation of stocks, by buying it you already spread the risks of individual stocks plummeting. Also because you buy a share of the fund, it costs less than buying all stocks within the portfolio.
From the description it might seem that it’s grandma’s best friend, but in reality ETFs can be different. There are some speculative ETFs too, but i’ll tell you about them in the end.
So important question to answer here: when do you need to buy it? The answer is when you're not that familiar with something but want to build presence.
For example, I might be an expert in the energy field so I know that I want to buy Occidental Petroleum and Schlumberger because I know that they are underfunded and will have lots of investments (not a fact). But I know nothing about biotech and tech but I believe that it’s future. People will live longer and everything will be digital (also not a fact). However, it would take me weeks to research industries and companies within it to make a choice what to invest in. Instead, I would buy an ETF or even better, a TTF devoted to biotech or the Metaverse.
Other cases to buy ETFs or TTFs are when you don’t have enough diversification in:
- Assets. I might not know anything about bonds except for that they are secure, so instead of looking for a yield that would cover inflation, I would buy “TIP” (iShares TIPS Bond ETF). An index of US Treasury inflation-protected securities with at least one year remaining in maturity.
- Commodities. Gold and silver provide good protection against inflation, but buying it physically is complicated. I would need to find or rent a place to store it and I also can't sell a part of it. Here the iShares Gold Trust would help.
- Countries. I know that the US market is one of the most stable ones, but developing markets such as India and China are growing faster. Since it’s another exchange, language and market, I wouldn’t know much about foreign stocks. Especially Chinese are confusing because they use numbers as tickers. So instead of learning Chinese and trying to understand the specifics of their economy, I could buy the MCSI China ETF, a fund that seeks to track the investment results of an index composed of domestic Chinese equities that trade on the Shanghai or Shenzhen stock exchanges.
- Industries. It’s not enough to have companies from different industries, because a) you can't know which ones will perform the best, b) if you want enough diversification, you would have to buy 50-60 companies, which is difficult to track.
So once you double checked your portfolio and found out that it’s not diversified in some of the aspects, then you can make a list of fields where it could be improved.
If you believe that the S&P 500 is enough, then you are not wrong. It’s a good basis, but also very low-yielding and boring (and the US economy is going through hard times now). So on top of this solid basis that averages 10% a year, it’s good to build extra layers that will boost your portfolio growth.
When you've defined that you need to improve the portfolio, try buying ETFs step-by-step as I have mentioned before: assets (e.g., Vanguard Total Bond Market ETF), commodities (iShares Gold Trust), countries (iShares MSCI Emerging Markets ETF), and finally industries and trends.
The last part is the most interesting because this is where you have the most variables and your choices can really accelerate the growth. Think about adding nitro to your race car. With this share of your portfolio (preferably not more than 30-40% if you are conservative) you can buy either something trending (like Energy), or long-term (Anti-aging stocks), or something you want to support (Diversity and Inclusion companies).
When you decide on the topics you are interested in, type it in your broker account or screener and you will see available funds to buy. For example, if you are into tech, you might type ‘Information Technology’ and you’ll get Vanguard Information Technology ETF. The first word is usually name of the fund, among which the biggest ones are SPDR, Vanguard, BlackRock (under the name iShares), Invesco. Then goes the theme or core assets, for example, Silver, Cybersecurity, or S&P 500.
How to choose ETFs?
Based on expense ratio, liquidity and desired composition. You can check expense ratios, composition on the official website of the fund or on ETF.com, as well as AUM (assets under management) which is directly tied to liquidity. The lower the expense ratio, the better. The bigger the AUM, the better. Composition is a controversial thing in ETF. On the one hand, they have a lot of stocks for diversification, on the other — they don’t give enough specialization and offer hundreds of random stocks.
As a better alternative, TTFs or thematic trading fractional are model portfolios made of 10-15 stocks, selected based on volatility and reward. They offer a variety of topics and causes to invest in, from Inflation-Proof stocks and Women-led companies to Cloud Computing and AR/VR stocks. And the expense ratio is only 1%.
Adding ETFs or TTFs is a safe way to start investing or diversifying your current holdings. Start with building a solid basis with the S&P 500 and continue growing by buying more trending and industry-specific funds.
Great investing ideas for the end of 2022:
- Gold mining companies (not only tied to gold prices but also pay dividends)
- Inflation-Proof Portfolio
- Coal mining
- Emerging markets
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