Investment strategies are plans for achieving specific results. Some strategies are fairly straightforward – though not necessarily simple – such as allocating your investments across a number of asset classes to help manage portfolio risk.
In other cases, a strategy may require two or more steps to produce the results you are after. For example, you might use an option spread, which involves purchasing one option and writing, or selling, another to achieve limited gains while protecting against serious losses.
ETFs can be useful tools in a variety of investment strategies. For starters, these funds are transparent, so you always know what you’re buying. In addition, you can usually trade them easily and quickly. And since there are ETFs linked to a variety of investment products, you can also use them in combination with individual securities, options and futures contracts, or other ETFs.
If you have a large amount of cash on hand—from a bonus, a retirement plan payout, or inheritance — you may decide to purchase shares in a stock ETF rather than putting your money into money market accounts or other short-term vehicles while you develop your long-term investment plan. There is a potential advantage but also some risks in this approach.
You can invest for the short term in several ways. Here are some features you may want to look for:
- Low expense ratios.
- Transparency and tight tracking to an underlying index.
- Flexible trading, including using limit orders and short sales.
- Ability to invest flexible amounts of cash.
- No expiration date or need to roll over a position to keep money invested.
On the plus side, you may realize a higher return. But ETFs are less liquid than money market funds, so in a volatile equity market, your assets could lose value. You may pay commissions to buy and sell ETFs, which could offset any gains. And unlike CDs, which are another choice for short-term holdings, ETFs are not insured.
Picking winners (and losers)
In general, choosing an asset allocation for the bulk of your portfolio and sticking with it has a lot of merit as a long-term investment strategy. However, there are times when you might decide to change your allocation for tactical reasons by putting money into an individual investment or market sector that you expect to outperform its historical average or the rest of the market.
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ETFs are one of the easiest ways to put a tactical allocation into practice. For example, if you spot a positive trend in the retail sector but aren’t sure exactly which individual stocks will gain most, an ETF linked to a retail index can help you invest in that sector while reducing the risk of investing in just one or two companies. Conversely, if the trend you spot suggests a certain sector is in for a rough period, selling short an ETF tracking that sector is much less risky and almost certainly cheaper than identifying and selling short the stocks you expect to take the biggest hits.
As part of your investment strategy, you may decide to sell securities that have lost value in order to offset capital gains and reduce the tax you owe when filing your annual tax return. But what if, within a week after you sell, the security rebounds? You would probably like to repurchase it to benefit from its potential for greater increases in value. But if you do, you won’t qualify to take the loss when you calculate your taxes because of what’s known in tax law as the wash sale rule.
According to this rule, if you purchase a “substantially identical ” security within 30 days before or 30 days after a sale, you don’t qualify to claim a loss on that sale. One alternative you might consider is to combine the sale of the security that has lost value with the purchase of an ETF linked to an index that tracks that security even if the security you sold accounts for 10% or more of the index, your ETF investment would be considered similar but not identical, and you would qualify to take the loss plus be a position to benefit from potential gains.
After 30 days, you could repurchase your original security and sell the ETF if you prefer. A variation on this strategy is to replace an ETF you sell at a loss with an ETF linked to a different index in the same sector. Even if the two indexes overlap in some ways, they are not identical — which you will know because ETF portfolio holdings are transparent — so you will be able to take the loss on the ETF that declined in value.
As a rule, dollar-cost averaging, which requires investing the same amount in the same security on a regular schedule, is a good strategy. But it isn’t always well suited for ETFs because of the cost of potential commissions. Even if pay just $9.95 per trade, the rate on a $100 monthly purchase is nearly 10%. But there may be solutions. For example, for a flat fee, calculated as a percentage of assets under management, you may be able to build an all-ETF portfolio without paying commissions on individual trades. Or you may use a broker that charges no commission at all on some ETFs.
However, it is smart to check minimum balance requirements and the cost of selling shares before you decide.
Top ETF Investing Strategies You Have To Know by Inna Rosputnia
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