How to Diversify With ETFs
Diversification is an investment strategy that is widely used to minimize financial losses in a portfolio by spreading invested funds across different asset classes. Effective diversification is achieved when a portfolio is invested in a broad range of securities that perform differently in varying economic and market conditions, including equities, bonds, commodities, real estate and/or cash. Purchasing or short selling Exchange Traded Funds is a cost effective way to diversify given that the funds are grouped securities which are invested in one or more asset classes. In other words, buying a single ETF mimics buying a basket of securities.
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Instructions
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Calculate the amount of capital you have available to invest in your investment portfolio.
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Research the wide variety of ETFs that are available using the Internet. The increasing popularity of investing in ETFs has led to the introduction of many different types including equity (broad or index-linked), bond, commodity, currency and specialty funds.
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Determine which asset classes to add to your portfolio and choose your ETFs accordingly. When choosing an ETF, research the basket of securities that make up the ETF. To minimize portfolio risk, it is important not only to diversify across different asset classes but also to diversify within one asset class. For example, investing in a bond ETF will provide more consistent income and less short-term volatility versus investing in an equity ETF. Or, buying different stock ETFs invested in a variety of industry sectors offers diversification within the equity portion of your portfolio.
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Purchase ETFs through a broker such as TD Ameritrade, ShareBuilder or Scottrade or through an investment management company such as Vanguard or Fidelity.
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Follow your ETF investments regularly using the Internet and adjust the portfolio depending upon market conditions. For example, if interest rates are widely anticipated to rise, favor ETFs invested in stocks versus ETFs invested in bonds.
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Tips & Warnings
ETFs tend to have lower expense ratios than mutual funds.
Use a discount broker to purchase ETFs as the fees will be lower than a full service broker or an investment management company.
ETF prices fluctuate with market movements, therefore experiencing losses as well as gains.
Check broker trading fees for buying and selling ETFs as certain brokers charge high fees for frequent trades.
References
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