Exchange Traded Funds Investing Strategies

July 24, 2008

In our final part of this three part series covering ETF investments, we’ll look at different strategies for investing with exchange-traded funds. Have I bored you? I hope not! Actually taking the time to learn about the hundreds of different investment products on the market is tedious, but the reward will be great. If you take the time to educate yourself about investing, budgeting, insurance, and ways to save money, you will be a wealthy person in your later years. To recap, the ETF has all of the diversification of a mutual fund, it’s sometimes cheaper than index funds, trades like a single stock, and you can buy funds that target certain sectors and/or markets.

Here are four different strategies for investing with exchange-traded funds:

The Primary Method

The primary method is the approach that the ETF would be your primary investment vehicle in your portfolio. The exchange-traded fund is designed so you can get exposure to a broad range of securities at a low expense. Instead of buying a 100 single stocks, you could buy a commodities ETF that targets the entire commodities sector. This is a risky method to only use ETFs for your primary investment strategy. it’s risky because many ETFs don’t have a track record longer than 10 years. If you want to buy and hold an ETF, it’s hard to judge its performance based on one or two years of performance.

Dollar-Cost Averaging Method

If time is on your side, let the power of compound interest take over for you with this method. Dollar-cost averaging is a great method to use for investing in ETFs, mutual funds, and bonds. The idea is that you invest a fixed amount of money at a given interval such as every month. This eliminates the need to time the market. You will buy less shares when the price is high and more shares when the price is low. Over a long period of time, the average cost that you purchased the shares will outperform a method of trying to time the market. If you want to experiment with an ETF, this is the method for you. This is the best method for those of you who don’t want investing to be your full-time job. Let the money pull automatically from your checking account and watch it grow over a long period of time. it’s a beautiful thing.

Sector Rotation

For those of you who are more active traders, this could be the method for you. If you read the Wall Street Journal religiously and keep track of market trends, then you should consider sector rotation for your exchange-traded funds. The idea for this strategy is to rotate in the ETF that targets the hottest markets and rotate out the markets that are declining. For instance, in today’s market you would want to rotate in an energy ETF and rotate out a real estate market ETF. This method is very risky. It’s a method that relies on timing the market correctly. You need to know what you’re doing if you choose this method. Although, it would be a fund strategy to experiment with using less than 10% of your investment portfolio.

Asset Allocation Method

The idea of the asset allocation method is that our investment strategy changes as we age. When you are young, you can invest aggressively with equities, but as you grow older, you want to shift your investments to more steady, income-producing investments. Using an ETF to shift your assets can save you money, because it takes less trades to do it. You can rebalance your portfolio with a few changes in the ETF’s that you invest in, rather than switching out mutual funds for bonds and dividend producing funds.

The Bottom Line

Have I convinced you to try out the exchange-traded fund? I bought my first one recently in my 401(k). Our company complained enough that there were no exchange-traded funds or index funds in our plan to choose from, so they finally granted us a few ETF options. I am eager to see how it performs. It tracks the Russell 2000 index. The bottom line is that the ETF is a great alternative investment that can easily be implemented into your portfolio to provide diversity with low costs. They offer broader exposure to markets and sectors that index funds do not track. Speak with your financial advisor or other financial professional about your options to start trading exchang-traded funds.

When you get the chance, please comment on your thoughts, experiences, and questions about the ETF.

Writer Auditions – Author Erik Folgate – Offer Your Feedback


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Erik Folgate is a husband and father living in Orlando who's been writing about money online for 6 years. Digging himself out of $20k of debt after college and his former experience in the insurance industry give him some useful insights into personal finance issues.

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