With exchange-traded funds, investors can create a diversified portfolio that will help them reach their financial goals while also matching their risk tolerance profile.AFP/Getty Images
Exchange-traded funds offer investors simplicity, diversification and low-cost solutions to match their goals and risk appetite
Exchange-traded funds offer investors the ability to create easy-to-manage, well-diversified portfolios at a low cost.
The universe of exchange-traded funds (ETFs) is vast and continually expanding, which can make the task of building a portfolio with ETFs feel daunting. A good first place to start is to consider your risk tolerance, your goals for the money and when you might need it.
This helps determine asset allocation, often broken down into equities, fixed income and cash, says Chris McHaney, executive vice-president and head of investment management and strategy at Global X Investments Canada Inc. “Within each asset class, you look at the risk spectrum and match that up with your risk tolerance and time horizon.”
For example, an individual a few years from retirement may want a balanced allocation with 50 per cent invested in equity ETFs and 50 per cent in bond ETFs.
More aggressive investors might choose portfolios with 80 per cent stocks and 20 per cent bonds. Conservative investors can find asset allocation ETFs with 20 per cent stocks and 80 per cent bonds.
The easiest way for investors wanting “to build a properly allocated portfolio based on objectives and time horizons is in an asset allocation ETF,” says Alan Fustey, a portfolio manager at Bellwether Investment Management in Winnipeg, who runs ETF-based strategies for investors.
These all-in-one ETFs contain other ETFs, often providing exposure to global stocks and bonds, based on the aforementioned conservative, balanced and aggressive allocations.
“These portfolios automatically rebalance so you don’t get any drift from asset allocation,” Mr. Fustey says, noting management costs for asset allocation ETFs are often less than 25 basis points annually. (A basis point is one one-hundredth of a percentage point).
Typically, all-in-one ETFs contain other ETFs providing core market exposure. “When you get into the world of asset allocation in general, there are basically four core areas: cash and equivalents, fixed income, Canadian equity and then equity outside of Canada.”
Mr. Fustey further notes that individual broad-based, passive ETFs that are low-cost are also well-suited to providing core exposures for investors who want to build their portfolio themselves.
To that end, investors can build lower-cost portfolios with two or three ETFs than even all-in-one offerings, says Dan Bortolotti, portfolio manager with PWL Capital, which also offers ETF-based portfolios.
“If your goal is keeping costs to a minimum, then choosing the individual components will be a little cheaper,” he says, noting some broad-based ETFs have management expense costs of less than 5 basis points.
Another reason for building your own ETF portfolio is greater customization that you cannot do with an all-in-one ETF, he adds. “Maybe you wanted to keep all of your fixed income – your bond ETFs – in your RRSP,” where that fully taxable interest income can be sheltered until withdrawn.
In contrast, equity-based ETFs, which involve more tax-efficient dividends and capital gains, could be held in other accounts. “For example, you might want your Canadian dividend stock ETF in your non-registered account to take advantage of the more favourable taxation,” Mr. Bortolotti explains.
Of course, investors have many more choices than core exposures among ETFs, including sector specific funds – such as financials or energy – and thematic ETFs that offer exposure to particular trends like artificial intelligence.
Investors can also buy factor-based ETFs instead of core funds, which are market-cap-weighted funds that track a broad index like the S&P 500. Factor-based funds, in contrast, build portfolios of stocks based on value, dividend growth or momentum screens, among others.
The diversity of choice among ETFs provides investors with plenty of ‘building blocks’ to create low-cost and highly customized portfolios for themselves, Mr. Bortolotti says.
“If you want to allocate 5 per cent to a specific country, for instance, there’s likely an ETF that will allow you to get that exposure.”
Sector-based and thematic ETFs, however, are best kept to smaller allocations in portfolios, part of the ‘explore’ sleeve that is often more speculative with a high probability of not providing much additional value over core exposure ETFs, Mr. Fustey says.
“You can really slice and dice the portfolio to get a lot of different exposures,” Mr. Fustey says, noting that holding too many thematics can dramatically increase a portfolio’s volatility.
In turn, investors can be more prone to errors, notably buying thematic ETFs after a strong performance one year, only to sell amid poor performance the next year at a loss.
Still thematic, factor-based and sector-based ETFs are less risky alternatives to investing in individual stocks for those investors feeling the need to explore different corners of the market, Mr. Bortolotti says. “At least you’re diversified.”
For the cash allocation of the portfolio, investors can find ETFs paying monthly income, he adds.
Fund providers, as institutional investors, “can often get better interest rates on these savings vehicles than you can with a high-interest savings account from your bank.”
Overall, investors have near endless choices among ETFs and ways to build an all-ETF portfolio and therein lies not only the challenge but a potential risk.
Investors can have too many funds in a portfolio, making it difficult to manage and rebalance to their intended asset allocation.
Mr. Fustey recommends sticking to a few core ETFs, which are much easier to manage.
“It’s that old KISS principle, right? Keep it simple as much as you can.”
Advertising feature produced by Globe Content Studio. The Globe’s editorial department was not involved.