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ETFs in your Investment Strategy
Exchange Traded Funds (ETFs) are versatile, flexible and cost-effective investments, and depending on your market outlook and your risk tolerance level, there is likely room for ETFs in your investment strategy. ETFs can be used to invest conservatively, for growth, or for a more aggressive position in a particular sector or asset class.
The basic use of an ETF is to buy the broad market, such as an ETF that tracks the S&P/TSX 60 Index as an underlying benchmark for the Canadian market. This ETF will generally move with the market, so as the broad market goes up in value, so will the ETF. Conversely, if the market declines, so will the ETF.
More sophisticated ETFs provide investors with leveraged returns by using derivatives to magnify the returns of an underlying index or benchmark (for example, double (or inverse) the daily performance). Some offer single inverse returns for the purpose of profiting from a decline in the value of an underlying index or benchmark. Still others offer returns correlated to the value of commodities such as gold.
Because ETFs are listed on a stock exchange and trade throughout the day, ETFs also offer the flexibility to get in or out of a particular region, sector or asset class if there is a sudden positive or negative movement. With mutual funds, you redeem units of the fund based on the net asset value (NAV) at market close, which restricts your flexibility.
Steps in ETF Investment Strategy
When employing a diversified investment strategy, your portfolio should not be concentrated in one particular industry or sector. Because the universe of ETFs offered in the marketplace covers a wide variety of regions, sectors and asset classes, multiple ETFs can be used to build a well-balanced portfolio, thus managing risk and ensuring diversification. ETFs also have inherent diversification due to the diversity of individual holdings that make up the ETF.
