ETF investing has become a very popular method for investment portfolio diversification, and for good reason.
Like mutual funds, Exchange Traded Funds (ETFs) are baskets of stocks from various companies within a specific market or sector, but they’re cheaper and have the significant advantage of trading like stocks.
If you’re already familiar with the index-mirroring structure of these unique funds, you may be wondering exactly how to invest in ETFs in order to make the most of everything they have to offer.
Now let’s have a look at some of the investment strategies that have proven to be the most effective for the individual investor.
1. Use ETFs as a Diversification Tool
Like mutual funds, the diversification of securities offered by Exchange Traded Funds allows investors to explore and successfully meet a broad range of investment objectives.
While they are not as aggressively managed as other index funds, ETFs do benefit from professional supervision, just the same.
ETFs provide you with convenient and effective exposure to a variety of regional and international markets, sectors, industries, and asset classes, such as bonds, REITs and various money markets, all of which can be easily accessed and traded as clusters of company shares.
Designed to mimic the returns of the markets they represent, the unique structure of ETFs makes them the ideal diversification tool for your portfolio, particularly since they lend themselves to a number of investment strategies that can suit the needs and preferences of every investor, large or small.
[alert-note]⇒ Investing Tip: Looking for a diversified portfolio? ETF is the best vehicle for diversification![/alert-note]
2. Use ETFs as Your Primary Type of Investment
Because they allow you to quickly, conveniently and inexpensively invest in both entire markets, and individual market segments, ETFs make a great primary financial investment for your portfolio.
You can choose the market or sector that interests you, whether it’s the S&P 500, the energy sector, or the bond market, and enjoy maximum exposure to those indexes without having to incur the expense of buying individual securities or commodities.
While mutual funds do offer this same level of exposure, ETFs are significantly cheaper to invest in when you implement a buy and hold strategy, due to their minimal management fees.
By purchasing an assortment of equity and dividend-paying ETFs, you can develop a solid and diverse portfolio that’s based on all the desirable aspects of growth, income, and long-term stability.
[alert-note]⇒ Investing Tip: No matter what type of investment you look for, ETFs can be one of them![/alert-note]
3. Take Advantage of Variations in Economic Cycles
When you invest in ETFs, you have the ability to take advantage of predictable economic cycles through a strategy known as sector rotation.
This investment strategy simply involves moving your money from one industry sector to another, in order to try and beat the market in much the same way that a mutual fund manager does.
By analyzing market history and performance, and by identifying the best ETFs to represent specific market sectors, you can use the predictable nature of our cyclical economy to maximize your investment returns.
Rationally predicting the rise and fall of various market segments allows you to buy and sell ETFs in accordance with which ones will provide the best performance returns.
ETFs not only give you the range of exposure required for such a strategy, they are less risky than individual stocks since the high performers in a sector tend to balance out the low performers at any given point in time.
[alert-note]⇒ Investing Tip: You can utilize the sector rotation strategy to maximize your returns on ETFs![/alert-note]
4. Short Sell Your ETFs
Short selling ETFs is a complex investment strategy that goes well beyond the scope of our discussion here, but if you take the time for further research, you’ll find that this strategy offers some very attractive opportunities for significant portfolio returns.
At its most basic level, short selling involves ‘selling’ a security you don’t actually own, but have effectively borrowed, in order to profit by re-purchasing it later when its share price drops.
In essence, you are buying low and selling high, but in the reverse order.
The obvious risk associated with such a strategy is that, instead of share prices dropping as you expect them to, they may rise, with you on the hook to purchase them back at an ever-increasing amount that has no ceiling.
But because they are based on major index benchmarks, ETF prices tend to remain relatively stable, with little potential for rising out of control. And unlike individual stocks, ETFs can be short sold even after share prices have already begun to drop, making it easier to predict and benefit from a market’s downward momentum.
Short selling ETFs can also help you to protect your individual stock holdings.
If you hold a lot of shares of a particular energy stock, for example, you could choose to short sell shares of an ETF that represents that entire energy sector.
Since there’s a reasonable chance that any drop in price in the stock you hold will be reflected by dropping prices in its sector as a whole, your profits from short selling in this case would help to offset any losses generated by your individual stock holding.
[alert-note]⇒ Investing Tip: ETFs and stocks are nearly the same – You can fully take advantage of short selling techniques to profit from shorting your ETFs![/alert-note]
5. Invest in Inverse ETFs
As their name implies, Inverse ETFs are designed to generate returns that correspond to the opposite performance of a specific market index.
For example, if you expect a particular market or segment to decline, instead of selling off your stocks or trying to navigate the intricacies of short selling for profit yourself, you can purchase Inverse ETFs that essentially perform the task of short selling for you, without the associated costs.
Once you feel the market downturn has run its course, you can simply sell your Inverse ETF shares.
Investing in Inverse ETFs does warrant more detailed research before you implement such a strategy but, like short selling, it’s an effective investment technique that can help you to outperform the market and maximize your portfolio returns, while providing some protection from market risk.
[alert-note]⇒ Investing Tip: When the stock market is going down, buy Inverse ETFs![/alert-note]
The Bottom Line
Not only does ETF investing offer convenient and inexpensive diversity, it lends itself naturally to a range of unique and proven investment strategies.
In seeking the best returns possible, you would be well-advised to take the time to find out more about how these strategies can help to improve, rebalance and protect your portfolio holdings, in accordance with your evolving investor needs.