Fine-tuning your portfolio using ETFs

Imagine that you’ve built a basic portfolio that gives you broad exposure to stocks and bonds. To accomplish this, you might have selected individual holdings, ETFs, mutual funds or some combination of these. Knowing that you have the basics covered, you might begin to look at other investment opportunities. As you broaden your investment selections, ETFs can be used in ways that may not be so obvious at first glance.

Here are some particular situations where investors can use ETFs, in addition to using them for basic portfolio building.

When a new investment innovation such as cryptocurrency, or a new investing theme such as artificial intelligence, is first introduced, it might be unclear how to best exploit the opportunity. Because ETFs have become so popular, new ETFs that provide exposure to these emerging products or themes are often quickly created. Investing in a thematic ETF lets you benefit from the expertise and oversight of investment professionals to guide portfolio selections. While ETFs may not be a perfect solution for everyone, especially if you enjoy stock research and selection, it may be an easier and safer way to capitalize on an investing theme in its early stages.

ETF investing is well suited to investment sectors that might require a deep dive into company financials or special technical knowledge to properly evaluate that sector. Not all investors aim to be full-time stock pickers with the time to do a deep-dive analysis on every holding. However, they might be intrigued by a new investment theme such as electric vehicles and look to buy an electric vehicle ETF. Sustainable or environmental, social and governance (ESG) investing is another area where there are many issues to consider, and those issues can differ from industry to industry. Again, an ETF can provide vetted stock selection from industry professionals, often with access to company management, at a reasonable cost.

Investing according to a theme might be difficult for an individual if that theme requires research on stocks in many different industries. For example, small-cap growth stocks have periods where they outperform the broad market and can be a popular choice for growth-oriented investors. But these stocks are found in many different industry groups, and developing expertise in all of them can be overwhelming. A small-cap growth ETF may be a simpler, more convenient choice.

You may be learning about technical analysis to better understand price patterns and generate trading ideas, but maybe you’re not yet comfortable with this approach. Some investors paper trade or watch the financial markets for a period of time to get a better feel for its workings before committing any money. Investors who want some stock exposure while they’re learning could consider an ETF for either broad market or targeted sector exposure.

In addition, knowledge of technical analysis can be useful for ETF trading as well as for stock trading. Common technical indicators such as moving averages and relative strength indicators can help evaluate trades in ETFs in the same way that other investment vehicles are evaluated. The liquidity and narrow bid-ask spreads of many ETFs means they tick some of the boxes that traders look for when searching for suitable trading vehicles. Technical analysts might also be interested in ETFs that focus on or incorporate some technical market aspect — for example, there are ETFs that track volatility, a key technical indicator for many traders.

In the same way that novice technical analysts can use ETFs while they learn their craft, the same can be said for novice fundamental analysts. ETFs can provide convenient broad market or sector exposure while an investor studies and evaluates the fundamentals of different companies. Even once you’ve grasped and are regularly using fundamental analysis, it can be very time consuming. ETFs are always available to fill in the gaps and diversify your portfolio while searching for great stock ideas.

Options are a speculative investment product with a number of inherent risks. Many option traders won’t want to commit all their investing capital to option trading. While option traders are benefitting from leverage and the chance to exploit short-term stock moves, their non-speculative capital can be invested in index ETFs for convenient broad exposure to other asset classes. Other speculative-style traders can also benefit from this approach.

The majority of ETFs are index-based and aim to replicate a specific index or benchmark, which can be especially useful when investing in some foreign stock markets. Many foreign markets can be hard to trade because of time differences, currency fluctuations and regulatory restrictions. However, most foreign markets will have an established benchmark index and many of them will have ETFs available that track those indexes. Buying a foreign market index ETF gives you exposure to the performance of that market without the need to work out the logistics of trading there.

These are just some of the additional ways that ETFs can play a part in portfolio building.

For more details on the many types of ETFs now available, check out Types of ETFs. That rundown might spark your own ideas about other ways to use this versatile investment product.