Achieving wealth creation goals by building a cost and tax efficient portfolio is never easy, but index ETFs can be an invaluable tool to do it.
Whether it’s portfolio construction or portfolio management, there are a wide range of applications for ETFs depending on your life stage, goals and risk profile.
Building a portfolio
A combination of ETFs covering different asset classes and markets can help build a robust, diversified portfolio at a low cost:
1. Use ETFs as core holdings
For many, ETFs are the ideal core of their investment portfolio due to their tax efficient structure and returns that closely match the benchmark.
An index ETF holds a broad spread of securities and features very low turnover levels. (Vanguard’s four diversified index ETFs provide exposure to over 10,000 securities.)
2. Reduce risk through diversification
If you are looking to improve diversification within your portfolio, or build a well-diversified portfolio, ETFs provide an excellent solution as they invest in all or a representative sample of the companies, in their benchmark.
The right ETF can provide instant diversification, and in turn reducing individual security risk in the portfolio. This is particularly important if you hold concentrated share portfolios focused on the ASX.
3. Add inaccessible asset classes
ETFs can be an easy way to introduce hard-to-access asset classes into a portfolio.
Examples – International shares, Emerging markets, international bonds, active value stocks, minimum volatility factor.
Listed ETFs that track a diversified index makes it simple to achieve broad portfolio diversification or create customised portfolios.
4. Implement different portfolio strategies
ETFs simplify the introduction of investment strategies like ‘core and satellites’. They can be used to construct a robust, diversified core for the portfolio to closely track the required index.
Above benchmark (alpha) returns can be added from satellites invested in securities or sectors with the potential to outperform.
Managing investment portfolios
ETFs make many investment management tasks easier:
1. Simple portfolio rebalancing
As they are traded in the same way as shares, ETFs make rebalancing your portfolio or exposure to different asset classes easy.
If your portfolio has moved away from its strategic asset allocation, ETFs can be used to quickly and easily correct the imbalance.
2. Lower management costs
ETFs are a handy tool if you are aiming to reduce your total investment management costs. (Vanguard’s diversified ETF funds have a 0.27 per cent annual fee.)
Low management and trading costs also make ETFs a cost-effective place to temporarily hold investments. You can maintain exposure to the market while you work on their longer term asset allocation.
3. Reduced costs for SMSFs
Many SMSF trustees prefer direct shares over managed funds due to cost, but this approach can make it difficult and expensive to create adequate diversification and manage multiple direct share holdings.
ETFs provide a great, cost-effective alternative as either the core equity holding or a fully diversified portfolio.
ETFs offer advisers invaluable tools for building and managing low-cost, diversified and tax efficient investment portfolios in a range of situations.
Key things to remember
ETFs are a simple and cost-effective way to diversify your investment portfolio. With ETFs it’s easy to:
- Invest in markets that are difficult for individual investors to access (such as emerging markets or international bonds).
- Keep transaction costs low when investing in international assets or complex markets.
- Implement tailored investment strategies designed to achieve your individual wealth creation goals.
- Alter your portfolio holdings to take advantage of new opportunities or changing market conditions.