How ETFs Can Boost Your Portfolio

 | Feb 12, 2018 | 2:00 PM EST
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People invested more than $100 billion in exchange traded funds in January -- a record monthly inflow that drove global ETF assets above the $5 trillion for the first time ever. Impressive as January's figure was, it follows four consecutive years of record-breaking inflows for ETFs.

I recently attended the Inside ETFs 2018 trade show, the largest annual gathering for the ETF industry. The event in part celebrated the 25th anniversary of the SPDR S&P 500 ETF (SPY) , which tracks the S&P 500.

The SPY's assets recently cleared the $300 billion level, but it's just one offering in what has become a large and expanding ETF marketplace, with the vast majority of products listed on the New York Stock Exchange

While some ETFs like the SPY have been around for decades, ETFs as an asset class have only really come into the investing zeitgeist over the past few years, garnered a growing share of asset flows vs. mutual funds or individual stocks.

There are several reasons for ETFs' gains, from investors' desire for diversification to demand for exposure to certain industries or geographies at far more reasonable prices than mutual funds sometimes offer.

Other ETFs like the ProShares Short S&P 500 (SH) and ProShares Short Russell 2000 (RWM) (both of which we hold in the Trifecta Stocks model portfolio that I co-manage) allow investors to hedge the market. Those names partly shielded the Trifecta Stocks portfolio from the market's correction over the past two weeks.

I've also used ETFs in the past in areas like cybersecurity and aerospace, where I wanted broader-based exposure rather than having to ferret out one company that I liked. The two ETFs that I employed for that purpose were the ETFMG Prime Cyber Security ETF (HACK) and ITA iShares U.S. Aerospace & Defense ETF (ITA) .

And when we look at global economic data, we see that both the European and Japanese economies are turning. In the past, this would have raised questions like: "Which non-U.S. industries and companies are poised to benefit? What are the differences in financial statements compared to those of U.S. companies?"

But now, investors can get broad exposure to a foreign market through ETFs such as the Vanguard FTSE Europe ETF (VGK) , the iShares MSCI Japan ETF (EWJ) or the iShares Core MSCI Emerging Markets ETF (IEMG) .

Two other advantages that ETFs can offer over mutual funds:

  • They Trade Like Stocks. ETF prices move all day long rather than just once a day after the market closes, which is when financial-services firms calculate most mutual funds' share prices.
  • Investors Can Trade Options on ETFs. I've done so several times with the Utilities Select Sector SPDR ETF (XLU) and the Financial Select Sector SPDR ETF (XLF) .

Remember to Do Your Homework

But while some might think investing in ETFs is a walk in the park, you'd be surprised by the challenges. After all, the fact that assets are piling into the sector means that financial firms have launched all sorts of new ETFs -- some with interesting twists, but others that can make you scratch your head.

So, the name of the game is due diligence here, understanding such things as a given ETF's investment strategy, which companies it holds and how much each stock is weighted. Some ETFs have fewer holdings than others, while some have deliberately concentrated positions that can make them more volatile. (No matter how good the ETF's strategy looks, you want to make sure that it's liquid, lest you get dinged trying to buy or sell.)

One key lesson I took away from the Inside ETF 2018 conference was that the sector's ballooning assets are poised to lead to a new, different wave of products. These range from actively managed ETFs (which could put an even bigger crimp into mutual-fund inflows) to "alternative-strategy" ones. These promise to bring things like "long/short" strategies to individual investors rather than leaving them to institutional investors and high-net-worth individuals.

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