Investment strategies are structured plans designed to achieve specific financial objectives. Some strategies are relatively straightforward, though not necessarily simple, such as diversifying your investments across various asset classes to manage portfolio risk.
Other strategies may involve multiple steps to reach your goals. For instance, using an option spread strategy involves buying one option and simultaneously selling another to balance potential gains with protection against significant losses. This multi-step approach allows you to target specific outcomes while managing risk effectively.
ETFs are versatile tools that can enhance a variety of investment strategies. Their transparency ensures you always know the underlying assets you’re investing in. Additionally, ETFs are typically easy and quick to trade. With ETFs available across a wide range of investment products, you can effectively use them in conjunction with individual securities, options, futures contracts, or other ETFs to build a well-rounded and dynamic investment approach.
Short-term investing
If you have a significant cash influx—such as from a bonus, retirement payout, or inheritance—you might choose to invest in a stock ETF instead of parking your funds in money market accounts or other short-term options while you develop a long-term investment strategy.
This approach offers potential benefits, such as the opportunity to earn higher returns compared to short-term vehicles. However, it also comes with risks, including market volatility and the potential for short-term losses. Balancing these risks with your long-term goals and investment timeline is crucial for making an informed decision.
For short-term investing, consider the following features when selecting ETFs:
- Low Expense Ratios: Choose ETFs with minimal fees to maximize your returns.
- Transparency and Tight Tracking: Look for ETFs that closely track their underlying index, ensuring that their performance aligns with your expectations.
- Flexible Trading Options: Ensure the ETF offers flexible trading features, such as limit orders and the ability to short sell.
- Flexible Investment Amounts: Opt for ETFs that allow you to invest varying amounts of cash without restrictions.
- No Expiration Date: Unlike options or futures, ETFs do not have expiration dates, so you won’t need to worry about rolling over positions to keep your money invested.
Investing in ETFs for the short term can potentially offer higher returns compared to money market funds. However, there are several drawbacks to consider:
- Liquidity: ETFs can be less liquid than money market funds, which might pose challenges in a volatile equity market and lead to potential losses.
- Commissions: Buying and selling ETFs may incur commissions, which can erode any gains you might make.
- Lack of Insurance: Unlike certificates of deposit (CDs), which are insured, ETFs do not offer the same level of security, meaning your investment is not protected against loss.
Picking winners (and losers)
Generally, maintaining a consistent asset allocation for the majority of your portfolio is a sound long-term investment strategy. It provides stability and helps manage risk. However, there are occasions when adjusting your allocation for tactical reasons can be beneficial. This might involve directing funds into specific investments or market sectors that you anticipate will outperform their historical averages or the broader market. This tactical approach allows you to potentially capitalize on emerging opportunities while still adhering to your overall investment strategy.
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ETFs are a practical tool for implementing tactical allocations. For example, if you identify a positive trend in the retail sector but are uncertain about which individual stocks will perform best, an ETF linked to a retail index allows you to invest in the entire sector while mitigating the risk associated with selecting just one or two companies. Conversely, if you foresee a downturn in a particular sector, shorting an ETF that tracks that sector is generally less risky and more cost-effective than identifying and shorting individual stocks expected to decline the most.
Wash sale
As part of your investment strategy, you might sell securities that have lost value to offset capital gains and reduce your tax liability for the year. However, if the security rebounds within a week after the sale and you decide to repurchase it, you won’t be able to claim the loss for tax purposes due to the wash sale rule. This rule prevents you from deducting a loss if you repurchase the same security within 30 days before or after the sale. This ensures that the tax deduction reflects a genuine loss rather than a temporary paper loss.
Under the wash sale rule, if you buy a “substantially identical” security within 30 days before or after selling one at a loss, you cannot claim that loss on your taxes. However, you can consider a strategic workaround: instead of repurchasing the same security, you might buy an ETF linked to an index that includes that security. Even if the security constitutes 10% or more of the ETF’s index, the ETF is considered similar but not identical, allowing you to claim the loss on the original security while still benefiting from potential gains with the ETF.
After 30 days, you could then repurchase the original security and sell the ETF if you wish. Alternatively, you could replace a sold ETF with another ETF that tracks a different index within the same sector. Even if there is some overlap between the indexes, they are not identical, allowing you to claim the loss on the ETF that declined in value while maintaining a position in the sector.
Dollar-cost averaging
Dollar-cost averaging—investing a fixed amount in the same security at regular intervals—is generally a sound strategy. However, it may not always be ideal for ETFs due to the cost of commissions. For instance, with a $9.95 per trade commission, a $100 monthly purchase incurs nearly a 10% cost.
There are ways to address this issue. Some options include:
- Flat Fee Accounts: Opting for a flat fee, calculated as a percentage of assets under management, can allow you to build an all-ETF portfolio without incurring individual trade commissions.
- Commission-Free ETFs: Using brokers that offer commission-free ETFs can also reduce costs.
It’s important to consider minimum balance requirements and potential costs for selling shares when choosing a strategy.
Top ETF Investing Strategies You Have To Know by Inna Rosputnia
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