Here’s how to use exchange-traded funds in 3 popular investing strategies
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Whether you’re starting to invest or nearing retirement, there are several ways to use exchange-traded funds, or ETFs, to achieve your financial goals, experts say.
An ETF is like a basket of individual assets, such as stocks or bonds, with shares that trade on an exchange throughout the day. Generally, ETFs are cheaper than mutual funds, with average fees of 0.17%, compared with 0.44% for mutual funds, according to Morningstar Direct.
“It’s a quick way to get instant market exposure at a really low cost,” said certified financial planner Ben Smith, founder of Cove Financial Planning in Milwaukee, noting that ETFs can be bought or sold like a stock.
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Here’s how to leverage ETFs with three popular investing strategies.
1. Dollar-cost averaging
If you’re nervous about stock market volatility, some experts suggest dollar-cost averaging, which is investing a set amount of money at regular intervals, regardless of market activity. One example is automatically contributing to your 401(k) every pay period.
“ETFs make things really easy,” said CFP Michael Nemick, co-founder of Thrive Retirement Specialists in Dearborn, Michigan. “It’s reduced the complexity that used to be involved with managing a broad portfolio of investments.”
Some ETFs represent hundreds or thousands of stocks “in a nice wrapper,” making it easy to dollar-cost average every month with two or three trades, versus hundreds or thousands, to achieve a diversified portfolio, he said.
2. Asset allocation
ETFs can also be bought or sold quickly to reach your asset allocation, or target mix of investments, which can be compared with building blocks in your portfolio.
Smith said ETFs are an “efficient and low-cost” way to plug different asset classes — such as stocks and bonds — into your allocation, depending on your financial goals. These can be adjusted periodically, known as rebalancing, based on stock market changes and your original asset allocation.
For some new clients, adjustments could involve simplifying “a hodgepodge” of individual stocks and mutual funds into a single broad market ETF, said Nemick. “When things are simple and transparent, it makes it a lot easier moving forward.”
3. Buy and hold
For long-term investors, advisors typically recommend a “buy-and-hold” strategy, regardless of market fluctuations. “You really don’t want to touch that investment portfolio,” Smith said, noting “you have to keep the blinders on” when the market is down.
Experts say tax efficiency makes ETFs well suited to buy and hold. ETFs are typically more tax-friendly than mutual funds because financial institutions can swap the underlying assets for others, known as an “in-kind” trade, which doesn’t trigger capital gains for investors.
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