ETF EDUCATION CENTRE

How should I use ETFs in my portfolio?

The answer depends on your investment personality. ETFs can be the foundation of a portfolio, the plaster that repairs the cracks or a simple speculative bet. The beauty of ETFs is that they are so versatile and useable in so many different situations.

A beginning investor with a bit of do-it-yourself gumption could, and should, use ETFs as the building blocks of a portfolio because ETFs are a low-cost option in two ways. For one, they charge a far lower management fee than brokerage firms. Second, ETFs can be bought and sold easily on a discount online brokerage. Investors can save a lot of money that would normally go to financial planners by starting an online account - assuming they take a long-term buy-and-hold strategy and not over-trade on their account and pile up the commission charges.

If you're a beginner, what should you buy? To answer that question, first determine the risk tolerance and how you want to divide your investing money. Risk-takers may want more equity exposure, while the more conservative investors will favour more heavily the safer but lower-returning bond funds.

The main cornerstones of a beginner's portfolio should include the ETFs of the major North American indexes - the iShares Canadian S&P/TSX 60 Index Fund (XIU.TSX) and the iShares Canadian S&P 500 fund (XSP.TSX). To round out the rest of the portfolio, you want to diversify with a bond fund, an international equity fund and a real estate investment trust fund to ensure that the investments are well diversified. The key is to keep rebalancing the portfolio - if the XIU fund starts to overwhelm the other funds, you'll want to balance the portfolio by adding more money to the underweighted areas. Academic studies repeatedly have proven that disciplined dedication to rebalancing the portfolio can pay off very handsomely in the long term.

For the more experienced investor who already has a varied stock portfolio, dabbling in ETFs can fill in the holes of your portfolio. You may find when reviewing your list of stocks, that you own all the big Canadian banks but have been missing out on the energy boom. The solution is to buy ETFs that specialize in the energy industry. Or perhaps you're missing some more international flavour on your monthly statement - the iShares MSCI EAFE Index Fund (XIN/TSX) would fit the bill (the fund invests in all major markets outside of the U.S. and Canada). ETFs can be an easy way to diversify your portfolio.

The more speculative investor can go a step further and play ETFs like race horses. Compared to regular stock-picking, the ETF bet is safer because it's like betting on an entire field rather than picking a specific horse - if you think the Korean stock market is going to roar this year, you can buy the ETF that matches the country's main Kospi stock index (like the iShares MSCI South Korea fund, EWY/NYSE), rather than having to pore through the Korean markets to pick a few individual stocks. If you think the gold bull run still has a few legs to reach $1000 an ounce but will top out at that point, you can make that call by buying a bullion ETF instead of buying gold bars, like the iShares Comex Gold fund (IAU/AMEX).