When you are constructing or re-organizing your portfolio, exchange traded funds (ETFs) are easy to use and offer much more than a traditional mutual fund. In general, individual investors are often ill-equipped to evaluate the prospective success of an actively managed fund, because of the lack of transparency in most mutual funds. Holdings are required to be disclosed only once a quarter, and by the time you receive these statements, the information could be out of date.

ETFs can be a valuable tool to individual investors when constructing a fully diversified portfolio. They offer relatively inexpensive access to areas of the market such as the various United States and international equity asset classes as well fixed-income investments, according to Investopedia.

Here are three areas ETFs can help in :

  • Portfolio Construction: ETFs give investors effective asset class diversification, which reduces overall risk within the portfolio. By reducing risk you are diverisified against the systematic behavior of U.S. large cap stocks. Modern portfolio construction theory holds that asset classes behave differently from one another. ETFs make it easy to build a well-diversified portfolio with just a few holdings.
  • Many Choices With ETF Asset Classes: There are many equity asset class exposures available through ETFs, and we’ll be seeing many more in the coming months and years. These include international large-cap stocks, U.S. small- mid-large-cap stocks, emerging market stocks and sector ETFs. Fixed income and inflation-protected investments are also available in ETF form.
  • Time Horizon: This is a personal timeline that indicates ones’ years until the time of retirement, desired or otherwise. A recent college grad may have 40 years in an investment timeline, while middle-aged people have 20 years, etc. You must budget risk accordingly and have a dose of fear concerning market volatility the closer retirement comes. Target-date ETFs can help you invest according to your time horizon – just pick the ETF that’s closest to your retirement date, and it shifts the allocations accordingly.
  • Trend Following: By watching the 200-day moving average with ETFs, you can spot those areas that are about to enter potential long-term uptrends, as well as exit areas that could be going into downtrends.  You can see where hundreds of ETFs are in relation to their trend lines by using our ETF Analyzer.

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.