When building an investment portfolio, it helps to consider diversifying among assets classes, sectors, market capitalizations and geographic regions. Along with stocks, ETFs are another asset class to consider, and are a popular choice for diversification due to their numerous benefits, with some investors choosing to build diversified portfolios entirely out of ETFs. If you have questions or need help with the process of building a diversified ETF portfolio, you could also consider reaching out to a financial advisor.
Why Build a Portfolio With ETFs
Exchange-traded funds (ETFs) are investment funds that trade on stock exchanges, similar to individual stocks. They’re designed to track the performance of a specific index, sector, commodity or asset class. Because ETFs offer investors a way to gain exposure to a broad range of securities within a single fund, provide diversification and reduce risk, they’re a a popular choice for investors looking to build a diversified portfolio.
Another benefit to ETFs is that they’re highly liquid, meaning they can easily be bought and sold throughout the trading day at market prices. Transparency is another key advantage, as ETFs regularly disclose their holdings, giving investors clear insight into their investments and making it easy to ensure a portfolio is properly diversified.
How to Build a Diversified ETF Portfolio Step by Step
Step 1: Determine Investment Goals and Risk Tolerance
Clearly define your investment goals and assess your risk tolerance. You can start by asking yourself questions such as whether you’re investing for long-term growth, income, or a specific financial goal such as retirement or buying a home. Understanding your risk tolerance is equally important, as it will influence your asset allocation. Those with a higher risk tolerance might allocate more towards emerging market ETFs, while conservative investors might favor bond ETFs.
Step 2: Choose Asset Classes
Decide on the asset classes you want to include in your portfolio. A well-diversified ETF portfolio typically includes ETFs that cover a variety of assets such as stocks, bonds and even real estate. Within each asset class, investors can further diversify by selecting ETFs that cover different market sectors, geographic regions and market capitalizations.
Step 3: Select Your ETFs
Select the specific ETFs that will make up your portfolio. When building a diversified ETF portfolio, it can be helpful to start by looking for ETFs with low expense ratios, as these costs can erode your returns over time. It’s also important to consider the liquidity of the ETFs and their tracking accuracy relative to their benchmarks. Within each asset class, you could start by choosing ETFs that cover different sectors, regions, and market capitalizations. For example, within the equity portion of your diversified ETF portfolio, you might include a U.S. large-cap ETF, an international ETF and an emerging markets ETF.
Step 4: Allocate Your Assets
Allocate your assets according to your investment strategy. This involves deciding what percentage of your total investment will go into each ETF. Your asset allocation should reflect your investment goals and risk tolerance. For example, a more aggressive investor might allocate a larger portion to equity ETFs, while a conservative investor might allocate more to bond ETFs.
Step 5: Regularly Rebalance Your Portfolio
Regularly rebalance your diversified ETF portfolio to maintain your asset allocation. Over time, the performance of different ETFs will cause your asset allocation to drift from your original plan. Rebalancing involves periodically buying or selling ETFs to return to your target asset allocation. This ensures that your portfolio remains aligned with your risk tolerance and investment goals. Regular rebalancing can help you manage risk and stay on track to meet your financial objectives.
Bottom Line
Building a diversified ETF portfolio involves a thoughtful and strategic approach that begins with understanding your investment goals and risk tolerance. By selecting a mix of asset classes, choosing low-cost and liquid ETFs, and carefully allocating your assets, you can create a robust portfolio that balances risk and return. Regular rebalancing is essential to maintain your desired asset allocation and stay on track with your financial objectives. This systematic process not only helps manage risk but also positions you for long-term growth. By following these steps, you can confidently navigate the complexities of investing and work towards achieving your financial goals, potentially with the guidance of a financial advisor to fine-tune your strategy and optimize your portfolio.
Portfolio Management Tips
- Having trouble deciding the best way to approach your investments? A financial advisor can help you create an investment plan for your needs and goals. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- If your investments pay off, you may owe taxes on the returns you earn. In the eyes of the IRS, this tax is called the capital gains tax. Figure out how much you’ll pay when you sell your investments with SmartAsset’s capital gains tax calculator.
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