Three approaches for building an ETF portfolio
Exchange-traded funds (ETFs) are an important part of many investors’ strategies. An ETF is an investment security that tracks an index, commodity, asset or specific sector. It can be bought and sold on the market like a regular stock.
ETFs are beneficial for many investors who have hopes for the performance of a security but do not want to be tied to the performance of one or two companies; an ETF enables investors to invest in a collection of securities that fall under their category of interest. This way, if one company underperforms but others are performing well, your overall investment should still come out on top. Contrast that with investing in an individual company: If it underperforms, then you take the full financial hit.
If you are considering building an ETF portfolio as part of your financial strategy, you should consider the three major types of approaches and which one best suits your strategy:
1. The broad approach
The broad approach is relatively the most simple balanced approach to an ETF portfolio. The idea is to build a balanced portfolio of stocks and bonds that is more heavily weighted in favor of one or the other depending on your risk tolerance.
For example, if you have a lower risk tolerance, you may want to put 60% of your funds into a world stock market ETF and 40% into a bond market ETF. On the other hand, if you are a higher risk taker, then increase the percentage to stocks while decreasing your allocation to bonds.
The benefit of this approach is that it is simple. It is easy to monitor and make adjustments to when you feel you need to shift the balance. The disadvantage, though, is the lack of fine-tuning. You may miss out on potential winners because of the broad, lower-risk approach instead of fine-tuning your approach in specific sectors or markets.
2. The narrow approach
The narrow approach takes the idea of the broad approach of targeting a stock ETF and a bond ETF but breaks it down into several ETFs instead of two. Your narrow approach might consist of anywhere between five and 10 ETFs spread into stock and bond ETFs according to your risk tolerance level and your strategy.
For example, your narrow approach might include one large-cap and one small-cap U.S. ETF and may include U.S. bond ETFs, international bond ETFs and sub-investment-grade ETFs.
The approach provides more balance and opportunities than you may find in the broad approach. However, it is more difficult to manage than the broad approach and may not present as many opportunities as a more fine-tuned approach.
3. The fine-tuned approach
The fine-tuned approach, as you might imagine, is the most difficult to manage of these strategies, but it also presents the most opportunities for growing your portfolio. Investors following the fine-tuned approach may have assets in dozens of ETFs spread across bond and stock markets. Additionally, it might include real estate, commodities, or other alternatives to the traditional stock and bond ETFs.
With the fine-tuned approach, investors can allocate their investments precisely to the sectors, assets or other securities they expect to perform well. On the other hand, along with being more difficult to manage, this approach also comes with more risks since the narrow approaches leave little room for support if the securities do not perform well.
Talk to a ProVise CFP® professional about building an ETF portfolio
At ProVise Management Group, our CERTIFIED FINANCIAL PLANNER™ professionals can get to know you and your current financial circumstances, goals, risk tolerance and personal values to help you develop a plan that works for you. We can also create a written plan for you at a fiduciary standard of care. All our written plans come with an unconditional money-back guarantee. If you are unhappy with your written plan, you can return it to us, and we will refund 100% of the fee paid.
Are you ready to talk to a professional about building an ETF portfolio? Contact ProVise today to schedule a complimentary consultation.