Using Exchange-Traded Funds for Portfolio Construction

Asset allocation is one of the most important decisions that you make as an investor. Having the right mix of stocks, bonds, cash, and commodities in your portfolio, and being well diversified within each asset class, can have a profound impact on your returns. Exchange-traded funds can be an easy way to gain this diversification. They can be cheap, flexible, and tax-efficient and may help you gain access to sectors and asset classes that would otherwise be closed off to individual investors.

Using ETFs for your core

For core stock exposure, many investors could be well served by ETFs. There are several inexpensive, broad market ETFs that track major large-cap indexes, like the S&P 500. This can be a very cheap way to gain exposure to the broad market, but investors who are dollar cost averaging (regularly investing small amounts over time) should carefully watch broker fees that may be incurred when buying ETFs, as they may push the overall costs of the investment over that of a traditional index mutual fund.

Getting you some exposure to undervalued areas

ETFs can also help you gain outsized exposure to undervalued areas of the market. Oftentimes, the short-term gyrations of the market leave certain sectors and subsectors trading for less than their intrinsic worth. Another important role that ETFs can play in your portfolio is to provide access to alternative asset classes like commodities and currencies. These areas, which used to be available only to institutional investors and high-net worth individuals, can help further diversify your portfolio. Although most investors would want these asset classes to represent only a tiny fraction of their overall holdings, their presence in a portfolio can be helpful because they can be uncorrelated to broader stock market returns.