After hitting the markets more than 17 years ago, exchange traded funds (ETFs) have become one of the most successful financial tools available. Be it short-term trades or long-term holdings, ETFs are a dynamic tool for today’s sophisticated investors.
Elizabeth Ody for Kiplinger remarks that ETFs are cheap, provide greater control over taxes, allow for exposure to new investment frontiers, and they’re on average cheaper than mutual funds. [10 Reasons to Trade ETFs.]
ETFs, though useful, are still a financial instruments that need to be used with understanding and caution. Having more arrows in your quiver isn’t necessarily always helpful. You have to have a strategy and a plan.
Ody outlines four strategies for using ETFs and we added a bonus fifth:
- Core Portfolio. An investor’s core portfolio should include securities composed of large-cap companies. By investing in sector ETFs, an investor may also limit the damage bubbles could potentially inflict on an portfolio – hold ETFs in the nine major market sectors in equal proportion and rebalance quarterly. [Sector Rotation and ETFs.]
- Tax Purposes. ETFs allow an investor to take advantage of investment losses for taxes purposes without losing gains or shifting asset allocations. For instance, to harvest losses for taxes, one would sell the shares and stay out of the stock for at least 31 days. However, an investor may invest the proceeds into a sector-related ETFs and ride any potential within that 31-day period. [5 Things to Know About ETFs and Taxes.]
- Be a Tactician. ETFs provide investors exposure to a sector, which helps reduce the risks involved with investing in individual companies. Investors will have to do some homework on the sectors they are buying into, paying particular attention to the underlying holdings of an ETF. [How to Choose and Trade ETFs.]
- Bonds. The U.S. bond market leans toward government debt. Default risk on U.S. bonds are relatively safe, but government debt is sensitive to interest rate movements. Treasury Inflation-Protected Securities (TIPS) may hold up better in an environment where interest rates rise along with inflation. Other ETF options available include, agency guaranteed mortgages, corporate bonds, municipal bonds, junk bonds and even international sovereign debt. [The Stellar First Half of Treasury ETFs.]
- Trend Following. ETFs and trend following are a natural fit, thanks to the fact that they share the diversification of mutual funds and the liquidity of a stock. You can buy and sell when you want to without penalty or additional fees (outside of commissions, in most cases). On our site, you can also set up alerts so you don’t miss key trend crossovers. [Here’s More on How Trend Following Works.]
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.