Use ETFs To Allocate A Portfolio Designed To Meet Your Income Needs

Even investors and traders who focus on single stocks can benefit from a portfolio of exchange-traded funds to create a full allocation. 

Why is it important to allocate your portfolio? That’s because you may be overweighted in a particular asset class or sector, which can cause steep downdrafts if that asset class tumbles.

Owning a wider range of investments is a way to smooth your returns, and help mitigate portfolio losses. 

In fact, you can build your entire portfolio using ETFs. I understand that many readers enjoy trading individual stocks, but I worked with many clients who held a fund allocation outside their trading portfolio, or even outside their single-stock investment accounts.

So it’s not necessary to use one instead of the other. 

What kind of ETF portfolio is best for you? It depends on your investment goals, time horizon and risk tolerance. And yes, it’s possible to dabble with alternative asset classes or favorite themes within your ETF portfolio. It doesn’t have to be all stodgy and “prudent,” as many traders believe.

ETFs are a good way to achieve broad portfolio diversification because they tend to be inexpensive, relative to mutual funds. They also offer built-in diversification, which is harder to attain using individual stocks. 

Many ETFs will disclose their holdings every day. For example, Cathy Wood’s Ark Invest ETFs send out a report every evening of buys and sells. Those reports have become popular among growth investors who want to look over the shoulder of professional investors with a proven track record of identifying disruptive companies. 

Some investors believe an ETF portfolio means giving up active management, but as the success of the Ark funds illustrates, that’s not necessary. 

One of the biggest advantages of an actively managed ETF is its tax efficiency, especially when compared to a mutual fund.

With an ETF, you realize capital gains when you sell shares, not when the fund company makes trades within the account, which is the case with a mutual fund. 

That’s less relevant if you hold an actively managed fund in a 401(k) or other qualified account, such as an IRA. 

But if you hold funds within a taxable account, you can benefit from active ETFs’ preferential tax treatment. 

Your approach to ETF investing will vary, depending on a number of factors. For example, there’s a growing sentiment among investors that traditional stock-and-bond index funds won’t deliver the necessary return. 

If that’s a concern for you, there are many ways to allocate tactically. That is, using ETFs as part of an active portfolio strategy. You (or your financial advisor would shift the allocation of asset classes or categories to capitalize on stronger sectors, or to take advantage of mispricings. 

With this strategy, an investor can capture uptrends that he or she may not enjoy - at least not to a large extent - in a pure index portfolio. Investors in tactical portfolios can still use index funds, and most do. But it gives you the latitude to fine-tune your asset mix according to market conditions. 

At its most basic, an index allocated ETF portfolio could consist of something extremely simple, such as a 60% holding in the SPDR S&P 500 ETF (ASX: SPY) or the iShares Core U.S. Aggregate Bond ETF (BMV: AGG). 

That’s better than doing nothing, or leaving your portfolio a disorganized collection of “stuff,” but you can certainly improve upon that basic allocation with international funds, alternative investments, and, market conditions allowing, some short-term, high-quality bonds. 

As with stocks, you’ll find that too many holdings can create a portfolio with no clear direction. It can also result in duplication. For example, as a financial advisor, I worked with numerous clients who owned several large-cap U.S. funds, without realizing what they held. That’s less than ideal, as it gives you a large exposure to one asset class. If it tanks, so does your overall account value.

The key is: Know what you own, and why. Diversification for its own sake is pointless, but if you know what’s inside your portfolio, you have a better chance of managing it to achieve a successful outcome.