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Exchange-traded funds (ETFs) are a type of investment that provide investors with the opportunity to purchase a basket of securities, such as stocks and bonds, with one transaction. An ETF trades like a regular stock on a stock exchange, and its traded price fluctuates throughout the day as you can buy and sell it on the stock exchange.
Since they allow investors to purchase different types of securities in one easy purchase, investing with ETFs can be a great way to diversify your portfolio and build long-term wealth. However, that is a possibility only if you understand the fundamentals of ETF portfolio management. Having said that, here are some smart practices to construct a well-rounded ETF portfolio and maximise gains, all while mitigating risk through effective diversification techniques!
- Choose your asset classes wisely
When constructing an ETF portfolio, it’s important to choose different asset classes that are not correlated with one another. This means that when one class appreciates, the other should not move in the same direction as it helps reduce overall volatility and risk in your portfolio. Generally speaking, a good mix of asset classes includes stocks, bonds (fixed-income securities), commodities (precious metals), real estate investment trusts (REITs), etc.
It’s important to remember that not all passive funds are the same, and you should choose an ETF that fits your investment objectives. The index varies by asset class (debt funds , gold, equity), sub-asset class (small-cap, mid-cap, large-cap), country (US, India), sector (financials, healthcare, energy) or theme (clean energy).
- Decide on your asset allocation
Now decide what asset allocation will work best for your financial situation and goals. Asset allocation is the process of deciding how much to invest in different types of assets, such as stocks, bonds, commodities, etc. When it comes to ETFs, you can invest in different equity markets indexes such as Nifty 50, Nifty 100, etc., or sectoral indices like Nifty Bank. You can also choose from various international exchange traded funds that track global stock markets, such as the Nasdaq Composite indexes.
It is crucial to decide your asset allocation first and then identify what index could give you adequate exposure. For example, the NIFTY 50 index gives a weightage of approximately 37.40% to financial services, 14.72% to IT, 12.27% to oil, gas & consumable fuels, 9.35% to consumer goods, 5.60% to automobiles, and 3.17% to metals and mining. Such weightage exposes investors across multiple sectors while maintaining a balanced risk profile since no single sector dominates the index’s weightage too heavily.
- Don’t overinvest in single assets
Focus on spreading your investments on more than one ETF so that you can benefit from diversification and reap more consistent returns across different markets. Keep in mind that even though one particular fund may be outperforming all others at any given time, there is no certainty that this trend will continue. As such, investing too heavily in a single fund can be risky and end up costing you money if the market turns against it.
- Rebalance regularly
Creating and maintaining a diversified ETF portfolio requires periodic review of the underlying index performance, holdings, liquidity features, tracking error, and other standards. Changes in any of these components, sectors, or stock concentration call for re-evaluating investments. Staying up to date with these factors helps ensure that an ETF portfolio is suited to your objective, setting the foundation for long-term success.
From diversifying asset types, to rebalancing your holdings and staying up to date on current market events – keeping these helpful practices in mind can be beneficial to structure a mutual fund portfolio that works for you.
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