Exchange traded funds: six tactics to use

09 November 2017 by National Bank
Man trading in computer

Exchange traded funds allow an investor to diversify investments in a portfolio of securities, much like mutual funds do. What sets an ETF apart from a mutual fund is that an ETF will trade just like stocks and can be bought or sold during normal trading hours.

In Canada, iShares will be the most common provider for your ETF. iShares are a family of ETFs managed by BlackRock and they are traded on the Toronto Stock Exchange. ETFs have been gaining popularity across the globe for several years now. In fact, one of the world’s first ETFs began trading in the 1990s in Canada on the TSE.

ETFs may seem like a risky option since they are affected by market fluctuation. However, as you’ll find out, proper education and solid strategies can help you embrace the benefits that come with an ETF. Index funds do bear some similarities with exchange-traded funds, but we’ll list out the differences.

Just like stocks, ETFs are always in flux and easy to track. The fact that you can diversify, track them on the market and come with a lower fee makes them similar to index funds.

Here are six of the best strategies to employ in order to maximize the benefits offered by ETFs:

1. Diversify your portfolio

In addition to being easy to access and having lower management fees than index funds, exchange traded funds (ETFs) are perfect for diversification, making them an excellent choice for minimizing financial risk.

There are thousands of ETFs, each with its own characteristics, both in terms of the type of economic sector (information technology, financial services, food, commodities, precious metals, etc.) and their region (Canada, United States, Brazil, China…even New Zealand!).

The risks associated with ETFs can vary greatly. There are ETFs in conservative sectors such as public services. There are also leveraged ETFs that are riskier, but that have potentially higher returns. Both the cautious and courageous investor can find the one that suits them best.

This huge variety among ETFs allows investors to benefit from a diversified portfolio both with regards to investment sector and geographical area. Picture the Eurozone economy floundering while the economy in the U.S. is hitting home runs. The investor who had ETFs in both places would fare better than the investor who focused only on Europe.

2. Tax loss harvesting

Sure, taxes will always be there, but the way you invest will greatly determine how much you spend and save.

With the help of an ETF, you just may be able to reduce your tax bill.

To claim a tax loss on securities, you must wait 30 days before redeeming them. If you wish to claim a tax loss but want to hold on to the affected securities, you can invest in an ETF that allows you to maintain a position similar to what you already have. After 30 days, you can sell your ETF in order to redeem the previously abandoned securities.

3. Reduce your portfolio’s volatility

With the ETF market, some funds are designed to reduce the volatility of a portfolio, meaning possible fluctuations in the rise or fall of an investment’s return.

Low volatility ETFs are more heavily invested in “defensive” sectors like basic consumer goods, utilities and healthcare. These “defensive” sectors are less erratic than the average stock because they tend to grow alongside the market.

By investing in ETFs with low volatility, you reduce your portfolio’s risks while taking advantage of increased market performance. However, ETFs trade on the stock exchange like shares do, making them investments that are somewhat susceptible to unpredictability.

4. Take advantage of ETFs’ liquidity

Since ETFs are highly liquid, they can be sold at any time without penalty (unlike mutual funds or GICs).

While the liquidity benefits are present, investors should note that the composition of the ETF and the trading volume of the individual securities will affect the degree of its liquidity. Other things that may affect liquidity is the trading volume of the ETF and the investment environment itself.

5. Tap into the US housing market

There are a few ETFs that are well positioned to take advantage of the US housing market, including the Vanguard REIT Fund, the FTSE NAREIT Residential Fund from iShares and the SPDR S&P Homebuilders Fund.

6. Play it safe

If you’re interested in an exchange-traded fund but are worried about market volatility, a safe route would be to invest in more “defensive” funds, such as those tied to consumer staples.

It may be tempting to write-off the ETF world out of fear. However, with the right strategy in place, it is possible to enter into a secure plan.

Granted, ETFs are not for everyone, so consult a National Bank advisor to find the best plan for your lifestyle.

 

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