ETFs and Tactical Asset Allocation
June 13th 2012 at 10:17am by Tom Lydon
ETFs appeal to many different types of investors because their low fees, tax efficiency and indexed approach make them a natural fit for long-term investors. Also, the ability to buy and sell ETFs during the day makes them attractive to traders.
There is also a middle ground of investors and advisors who use ETFs in so-called tactical asset allocation. “This strategy allows portfolio managers to create extra value by taking advantage of certain situations in the marketplace,” Investopedia explains. “It is as a moderately active strategy since managers return to the portfolio’s original strategic asset mix when desired short-term profits are achieved.”
ETFs can also be used in trend-following strategies centered around the 200-day moving averages. [An ETF Trend-Following Plan for All Seasons]
Some investors wonder how much they should trade ETFs. The answer, of course, depends on your individual situation, tolerance for risk, and other factors.
While some may “set-and-forget” ETF holdings, investors should still maintain some semblance of checking allocations if only to get into the habit of actively keeping tabs on the investments.
“A basket of ETFs certainly gives investors more diversity, more protection, but it’s good for all investors to get into the habit of looking regularly and asking, ‘Am I on track to meet my goals?’” Rajiv Silgardo, co-chief executive at BMO Global Asset Management, said, reports Eric Lam for the Financial Post. “One of the major lessons of the past few years is that ‘buy and hold’ does not mean ‘buy and forget.’”
Investors tend to get lulled into complacency as the ETF investment tool, with its cheap, broad market index approach, fits well with buy-and-hold investors. ETFs have an average expense ratio of about 0.55%, whereas the average expense on actively managed equity funds in 2011 was 0.93%, according to the Investment Company Institute. [What is an ETF? — Part 8: Trading Costs]
Silgardo suggests that the frequency at which investors rebalance should be dictated by movements in the markets, and how that affects an investor’s asset mix of equities and bonds.
“Five years ago I would’ve said once a year would be good. But monthly or quarterly is not bad,” Silgardo said in the article. “You need to find your own comfort zone. When you create an asset mix, it can change very quickly as markets move.”
“You rebalance when things make sense. When bonds are significantly cheap to equities — assuming it’s just stocks and bonds — you want to put [money] in there and vice-versa,” Larry Berman, chief investment officer and co-founder of ETF Capital Management, added in response to the traditionalists holding onto a 60 equity/40 bond split.
Additionally, Berman cautions investors from becoming overzealous in utilizing inverse/leveraged tools.
“Different ETFs have their place. The leveraged ETFs, the double bulls and double bears are only ever appropriate for very short-term trading, no more than a couple of weeks,” Berman said in the article.
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.