Understanding ETF Portfolio Indexing
October 9th, 2013 at 7:00am by Tom Lydon
Anyone can utilize passively indexed exchange traded funds to craft a diversified investment portfolio. But what exactly is ETF portfolio indexing?
As the name entails, ETF portfolio indexing is a portfolio comprised of index-based ETFs. Mitch Tuchman for Forbes points out the three basics every new investor to the investment vehicle should know.
“ETF portfolio indexing is owning ETFs (for their efficiency) in a portfolio (in order to rebalance when necessary) while attempting in each asset class to index (and thus beat active management over time),” Tuchman said.
To start off, ETFs are an investment tool that help investors gain exposure to a benchmark index through a single trade.
Before the advent of ETFs, investors would have to purchase every single security in a benchmark, such as the S&P 500 or Dow Jones Industrial Average, to replicate the index’s returns. Moreover, investors would have to regularly buy and sell hundreds of stocks to adequately mach the changes in the index.
With ETFs, investors can fully track an entire market, only paying a hundredths of a percent for the tool instead of trading hundreds of securities individually.
Secondly, a portfolio is the sum of a person’s investments, broken down by assets, for a long-term horizon. Different portfolios have varying strategies. For instance, some may focus on growth and gains over time and others may feature yield-generating assets.
The basic portfolio includes stocks and bonds, but investors should also diversify into foreign equities, small-caps, emerging markets, real estate and commodities to craft a well-rounded portfolio.
Lastly, indexing refers to owning ETFs that mimic index funds by closely following well-established indices. Investors would typically hold plain-vanilla index funds for long-term exposure and targeted niche or sector ETFs for short-term tactical positions.
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.