ETFs provide liquidity, flexibility and cost-efficient exposure to a broad range of asset classes, making them a good fit for many investors. But, that doesn’t mean they are an appropriate choice for all investment scenarios.
Investors who are considering adding one or more ETFs to their portfolio should first take a careful look at their own situation, investment style, knowledge level and time horizon to determine whether an ETF fits their overall investment strategy.
ETFs can be a great investment solution for a range of portfolio strategies and a solid choice for investors who are:
Employing a buy-and hold strategy - When investing a lump sum of money the low expense ratios of ETFs will go far toward offsetting the one-time brokerage commission when following a long-term, “buy-and-hold” strategy.
Knowledgeable about investing - If you are a knowledgeable, experienced investor who enjoys focusing on specific industries or on particular regions or countries of the world, ETFs might offer a more cost-efficient way to pursue these types of market opportunities than would single stocks or sector mutual funds.
Other ways to use ETFs in a portfolio
- Enhance diversification: The ever-increasing variety of ETFs available offers an easy and cost-effective way to provide a degree of diversification that would otherwise be too time-consuming and expensive to attain by purchasing individual securities.
- Act as a hedging-tool: Since ETFs share many of the trading characteristics of stocks, they can be used as effective portfolio-hedging tools. For instance, with ETFs, investors can specify limit prices, enter stop orders and even use other strategies to protect portfolio principal and/or to enhance portfolio return.
- Serve as a secondary portfolio: For investors with a primary portfolio made up of traditional equity and fixed-income investments, a secondary portfolio made up of carefully chosen ETFs can be constructed and occasionally rebalanced to maintain predetermined weightings.
- Provide a substitute for cash: ETFs also can be used as a transitional investment vehicle, to make use of cash that has been moved out of another investment due to ordinary or transitional management reasons.