What You Want to Know Before Building Your ETF Portfolio

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Investors are hearing more and more about exchange-traded funds (ETFs).  With nearly 2,000 ETFs available, investors may be wondering if the time to add this type of asset to their portfolios is now.  As with every class of investment, there are deliberations to be made before jumping in with both feet.

There are important considerations for investors to think about as they build their basic ETF portfolio in 2018.

While there is an estimated $3 trillion dollars on tap in ETF assets, analysts are leaning toward low cost, diversified passive ETFs as a sound investment path, of which there are several hundred ETFs to choose from.

Stock ETFs can access 5,000 or so different stocks from every part of the world.

Vanguard FTSE All-World ex-U.S. ETF (NYSE: VEU) and the Vanguard Total Stock Market ETF (NYSE: VTI) are two broadly accessible ETFs concentrating on hefty baskets of stocks.  With 1 percent exposure in excess of 19 different countries, VEU covers emerging to developed market economies.  VTI has an expense ratio of a mere .04 percent, compared to VEU’s expense ratio of .11 percent, making it the more affordable of the two.

The majority of analysts feel investing in stock ETFs is a good basic approach toward developing an ETF portfolio, but, there are other options for attaining broad exposure to a sizable group of global stocks.

Bond ETF options are far more stable than stocks, especially through times of recession.

Stocks are much more susceptible to going up and down during a recession, whereas bonds are likely to remain considerably more stable.  Investors who tend to get jumpy when their stocks plummet during a bear market could find bond focused ETFs a good choice for balancing out this segment of their portfolios.

Once an investor has decided to add bond ETFs to their portfolios, they will need to choose which types of bond ETFs they want to hold.  An excellent choice is government bonds because they usually hold up very well when stocks are performing badly.  The majority of government bonds are backed by the credit of the U.S. government, making them virtually risk free, owing to the fact there is a slim chance of default.  On the negative side, returns on government bond ETFs are typically lower.

Unlike government bonds, corporate bonds usually keep in step more with the market because they are issued by the same companies represented by stocks.  A corporate bond is debt security sold to investors by a company as a way of financing debt.  During recessions, 10 year bonds have a favorable track record, according to Forbes, and it is for this reason the Vanguard Intermediate Term Treasury ETF (NASDAQ: VFITX) is a solid option to counterbalance against a stock portfolio.  This ETF being rather un-diversified, investors might also opt for the Vanguard Total Bond Market ETF (NYSE: BND) to delve into options outside of the United States.

It is crucial for investors to think about the level of risk when investing in ETFs.

Although ETFs are usually viewed as a safer bet than many other types of investments, there is still risk.  If an investor requires money in the more immediate future, investing in the Vanguard Short-Term Treasury ETF (NASDAQGM: VGSH) could be a more prudent choice over a stock focused ETF.  Historically, the growth of VGSH has been steady, but, its yield is moderately lower than some of the aforementioned ETFs.

In recent months emerging market focused ETFs have experienced enormous growth.  Although ETFs in markets like China have done very well this year, they also have a higher potential for risk.  Some of the earlier mentioned international stock ETFs include emerging markets like India and China, but, there are other ETFs placing their focus on these markets.  Investors may be tempted to delve into these ETFs with both feet because they do appear inexpensive, but they can be rather risky.  Investors may want to limit their exposure to single country focused ETFs.

Leveraged ETFs will allow investors to keep losses in check while amplifying returns.

Leveraged investments are usually associated with magnified losses as well as gains, which may seem ineffective.  Indeed, it may be the case with futures and options, but, leveraged ETFs are a sound option for those looking to leverage their portfolios.

With a futures contract, an investor has made an agreement to buy or sell a commodity at a predetermined price at a future time.  Similar to placing a down payment on a car, an investor puts down a deposit which is a slight percentage of the total value of an asset when buying or selling a futures contract.  This deposit, or “initial margin,” usually 5 to 10 percent of the value of the futures contract, is affected up or down by the movements in the market.  If the market goes against the investor, say falling by 15 percent, the investor’s 10 percent initial margin is wiped out if he or she can’t meet the “margin call” of the additional 5 percent.  With a futures contract, an investor cannot hope to wait out a failing stock hoping to correct.

Similar in concept to futures, with options, investors additionally have the right, but not the obligation to buy a security in the future at a predetermined price; however, they have to pay a “premium” for this right, (options contract).  Options have a termination date; if the market does not move favorably for the investor before the specified date, they lose everything.

Leveraged ETFs are associated with an underlying market which allows investors to hold their positions until they are favorable.  There is no expiry date with leveraged ETFs; additionally, investors are not forced to sell and they will never go to zero enabling investors to hold on until the market is right.

For further reading on investing in ETFs, please, see Great Energy ETFs and Stocks to Investors Should Know.

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