Nathan Geraci is President of The ETF Store, Inc. and host of the weekly radio show “The ETF Store Show“.
Much has been written about the remarkable growth of Exchange Traded Funds (ETFs), along with their potential benefits. Lower costs, tax efficiency, and transparency are just a few of the possible advantages of using ETFs in your investment portfolio. However, a benefit that is sometimes overlooked is the simple fact that ETFs provide you with options.
Consider a relatively moderate investor in the 1990s. Back then, a well-diversified portfolio might have been comprised of 60% stocks and 40% bonds, the bulk of which represented U.S.-based companies. However, this common mix of primarily U.S. stocks and bonds was not necessarily used because it was deemed the best way to build an investment portfolio. Instead, other factors were at play, none of which had to do with determining the optimal mix of investments to provide the best risk-reward scenario for your portfolio.
For example, it has been well-documented that international stocks can provide diversification benefits to your portfolio. But 20 years ago, the ability for investors to invest in developed international economies, let alone emerging economies like China and India, were limited – and expensive. The same held true for broad-based commodities and precious metals – investments like gold, oil, and agriculture. If you wanted to own oil in your portfolio, you either had to buy (and store) barrels of oil in your backyard or play oil futures contracts – neither of which was a particularly attractive option. The end result was investors simply found U.S. stocks and bonds more accessible and cost effective to invest in. Therefore, most investor portfolios looked a lot like the aforementioned 60/40 U.S.-centric one.
Fast forward to today where the proliferation of ETFs has changed the game for investors. Currently, there are over 1,700 Exchange Traded Products spanning seemingly every asset class imaginable. Want to invest in mainland China? There’s an ETF for that. Silver? Of course. Emerging market bonds? Yep.
A wonderful aspect of ETFs is that they can allow you to easily express your longer-term views on the market. Concerned about inflation? You might consider an ETF holding Treasury Inflation Protected Securities (TIPS) or maybe a physically-backed gold ETF. Think frontier markets such as Kuwait or Nigeria are the next up-and-coming economies and future drivers of global growth? You can invest in an ETF offering broad-based exposure to these early-stage economies.
When it comes to successful long-term investing, two of the biggest drivers are proper asset allocation (i.e. being in the right mix of investments for your situation) and diversification (i.e. owning a variety of investments). Since different investments will take turns outperforming in any given year, these are both critical to achieving positive investment outcomes. ETFs have made it significantly easier for investors to allocate assets and build a diversified portfolio in an efficient manner. And, as additional benefits, you might just lower your investment costs, reduce your tax bill, and have greater visibility into exactly what you own.
