How to choose your ETF portfolio

Exchange Traded Funds (ETF's) are relatively new forms of investment vehicles that have been devised, in principle, to offer a relatively cost effective way to invest in the financial markets.

It can be very tricky to choose the right kind of ETF's because the ever-increasing choice available of different types of ETF's being introduced all the time.

Advantages of ETF's

An ETF has several distinct advantages over mutual funds. An ETF has lower annual charges than a mutual fund and, with commission charges with many online brokers being cheap, the overall charges are still significantly cheaper assuming an equal amount is invested in both.

• Learn about the different types of ETF's available. There are so many now that some of them are very vague and too narrowly focussed that could increase the levels of risk because it does not offer the kind of diversification that you might think.

Employ trading strategy

How you select the components of your ETF portfolio will vary depending on the type of investor you are. However, assuming you fit the characteristics of most investors and seek out consistent, if not heady growth over a long period of time, then you will want to fulfil several criteria in your investment plan.

Construct a portfolio of exchange-traded funds that has ETF's that track the broader indices like S&P 500, FTSE Ishares as core component of your portfolio.

You will want a good coverage of all the different types of investments such as:

• Large caps
• Small-mid caps
• Emerging markets
• Bonds
• Commodity stocks

Large cap stocks

Part of your ETF portfolio should be invested in large caps. Large caps offer the a great deal of security in terms of withstanding economic downturns better than smaller cap stock or stocks focussed on emerging markets. Of course, large caps also offer higher returns in income in the form of dividends. As most historians following stockmarket trends will tell you, dividends provide bulk of the real returns (minus inflation) in the long run.

Small caps

A well-constructed ETF portfolio will have money invested in small cap stocks. There are plenty of ETF's that focus on small caps. A significant proportion invested in small caps will offer the prospect of growth as opposed to the safety-first approach of large caps.

You will want some money in ETF's that track sectors that will provide huge potential for the future.

Emerging markets

Since the purpose of a portfolio is to diversify risk and at the same time invest so the value of the portfolio increases over time, ETFs are a great way to get some exposure to emerging markets.

Investing in ETFs that track stocks in emerging markets should also be a part of your portfolio because emerging markets give exposure to potentially very lucrative returns due to the high economic growth rates in these countries. Investing in individual stocks in emerging markets can be risky, but because the ETF will be more a tracker, this will reduce the risks.

Bonds

ETF's that track bonds can provide the assurance of pretty much guaranteed returns.

To minimise risk as much as possible, you can invest part of it in bonds and stocks of that have an interest in commodities like Gold.

Summary

So your strategy of devising an ETF portfolio should be like that of devising a portfolio of individual stocks. You should seek to employ a strategy that diversifies risk but at the same time offers the chance for significant growth.