Top ETF market strategies
One of the major benefits of investing in an exchange traded fund (ETF) is the instant diversification that they can offer. By making an investment in a FTSE 100 ETF, you are effectively spreading your money across 100 different stocks for one fixed fee. However, there are a few strategies you can follow to ensure that you are getting even more out of your investments.
1.The ‘asset allocation’ strategy
Asset allocation involves splitting your investment across a number of different sectors or markets.
‘While low fees are fantastic, you still have to have a very good asset allocation,’ says Oliver Smith, portfolio manager at IG. ‘We can all buy a very low-fee ETF just by scouring investment tables, but for most people, what you need is a robust asset allocation to help you through to your next phase of your lifecycle. Whether you're saving up for children's education or for a deposit for a house or for your retirement, you' will want a different asset allocation.’
For instance, if you want to gain exposure to the UK’s top-performing stocks and shares over the long term, you might allocate to a FTSE 100-tracking ETF. If you also wanted to benefit from the performance of commodities, you might allocate some money into ETFs that track the price of gold, oil or water.
As you become more confident with this strategy, you might choose to mix up your asset allocation on a regular basis, as your investment goals (and your risk profile) change.
Watch Andrew Craig, author of How to Own the World, explain the power of diversification.
Smith calls ETFs, which track the S&P 500 and FTSE 100, ‘headline indices – the real building blocks of people's portfolios,’ and they are a great place to start when pursuing an asset allocation strategy. However, it is important to remember that the stocks making up these markets can change on a week-to-week basis, so you should be prepared to adjust your asset allocation plans accordingly.
2.The ‘cost averaging’ strategy
Known as either dollar cost averaging or pound cost averaging (depending on where you live), this is probably the most common ETF market strategy – and it’s a lot simpler than it sounds.
You decide how much you are prepared to invest in your ETF, and how regularly you want to top up your investment. For instance, every month you might invest £200 into a FTSE 100 ETF. Depending on the performance of the fund, that £200 might buy you four units in an ETF one month, and five units the next. By continuing to pay the same amount of money regardless of these price fluctuations, you will actually benefit from a process called ‘cost averaging’ over time. So when the fund is cheaper, your standard investment will allow you to buy more, and when it becomes more expensive, you will buy less.
Read more about how pound cost averaging can smooth your investment returns.
3.The ‘alternative’ strategy
ETFs are a great way to gain exposure to the alternative sector without taking on too much risk. There are a number of ETFs focused on alternative sectors such as Bitcoin, the unsecured debt markets, private equity, and hedge funds, to name just a few.
However, alternative investments are often viewed as ‘high risk, high reward’ due to their volatile nature. For instance, IG’s top-performing and lowest performing ETFs of the past year were both focused on alternative investments. Commerzbank ETN - 2x VSTOXXF Daily Short posted a massive 12-month return of 1,910.17% (as of 18 August 2017), while the Commerzbank ETN 2x VSTOXXF Daily Long saw its value erode by 98.34% over the same period.
By using an ETF to invest in the alternative market, you can diversify your money and minimise your potential losses. Having said that, any exposure to alternatives should only ever make up a small percentage of your overall portfolio.
4.The ‘trend-based’ strategy
This ETF strategy is more commonly associated with direct stocks and shares investing. It is all about anticipating market movements, and acting accordingly. For instance, a flu epidemic might result in higher returns for pharmaceutical companies. To take advantage of any potential swing in the market, you might choose to invest in a pharma-focused ETF, before divesting again once you have reached your target returns. The low-fee structure of ETFs means that it is relatively cost-effective to switch from fund to fund if you feel that you want to capitalise on an upcoming or ongoing trend.
More experienced investors may also take advantage of seasonal trends, where money is diverted away from the main stock markets in the relatively quiet period between May and October, and allocations to certain sectors are increased at key times (for instance, retail-focused funds during the Christmas period).
Of course, the major downside of the trend-based strategy is that you could always get it wrong. For this reason, it is best to approach this strategy with caution.
You can buy ETFs on IG’s share dealing platform from just £5. Our ETF screener is a great tool to search for your favoured markets.
An investor should always read the ETF prospectus or Key Investor Document (KIID) before investing.