Most people will by now have heard that ETFs are an excellent asset to invest in, for beginners and more experienced investors alike. They offer a much better market exposure shielding compared to individual stocks, making the right market timing much less critical.
But do you know which are the best ETF investing strategies?
What are ETFs? Definition and Examples for new Investors
Exchange-traded funds, or ETFs for short, are a type of asset for investors, that pools together the money from hundreds or even thousands of investors and invests in assets such as stocks, bonds, commodities, and more. Like mutual funds, ETFs give investors access to a diversified portfolio of assets, but with lower trading costs than buying individual securities.
ETFs are traded on the stock exchange and can be bought and sold just like shares of stock, making them more accessible for investors with smaller amounts to invest. It is estimated there are way more than 8000 ETFs globally (source: ETP Landscape, BlackRock, As of 29 March 2019).
What are the asset classes of ETFs?
ETFs come in a vast number of asset classes and investing styles, from broad-market funds that track an index such as the S&P 500, to inverse ETFs that aim to profit from market declines and leveraged ETFs that are designed to amplify returns.
Here are the most common ones you should know, but keep in mind there are many more out there:
Let us go through each one of them to see how they differ. This will be important for understanding which ETFs to best use for your ETF investment strategy.
Commodities like oil or gold are attractive alternatives to stocks, especially for asset allocation diversification. Commodity ETFs are a great choice for diversification and make it easier to get into commodities than ordinary stocks. However, they are more complex and less transparent than stock or index ETFs, mostly because they often do not directly own the related asset, but use derivatives instead. Derivatives track the underlying price of the commodity and can carry more risk.
These ETFs allow you to either invest in a single currency (like the US dollar or Euro) or in a basket of currencies. Similar to commodity ETFs, this can be either done directly or through derivatives. Currency ETFs are interesting for those investing in overseas markets and wishing to hedge against currency risks.
These ETFs provide a steady return at potentially lower risk than equity ETFs, making such fixed-income ETFs a popular choice for diversification of the strategic core portfolio. These ETFs track a wide range of bonds, including government and corporate bonds.
Equity ETFs track (as the name suggests) an index of equity. They are the most popular type of ETFs and cover all equity markets such as Dow Jones Industrial Average or the S&P 500.
Equity ETFs also come in various sizes, from small caps to large ones, enabling investors to build their portfolios strategically. For example, you can choose tech or banking stocks, or focus on the businesses in a certain region or emerging markets. This makes them a very popular choice for many ETF investment strategies.
Similar to leveraged ETFs, the inverse ETFs also carry a much higher risk and reward potential. Here, the inverse ETF funds go up when the target index goes down. It reflects the „short selling“ position that traders can take with individual stocks.
Leveraged funds have much greater growth potential but also much greater risk compared to other ETFs: their goal is to maximize returns by borrowing more money (this is the leverage) to invest more. The leverage amount is indicated (e.g., a 3X leverage means that every 1 USD invested will add 2 USD borrowed).
Real-estate ETFs focus (as the name suggests) on holding stocks of the REITs category. REITs means real estate investment trusts. Instead of holding the actual real estate, this type of ETF allows you to invest in companies that own real estate across many sectors of industry (e.g., agriculture, industrial, medical) including residential properties.
These are a newer class of ETFs that is growing rapidly. In addition to the classical profit focus, they also consider environmental, social, and governance (ESG) factors. Carbon-credits ETFs are a great example of how you can invest in Sustainability with ETFs.
Overview of popular ETFs by type
It is important that depending on the ETF asset class you want to go for, you do your own research on what exactly to invest in given your risk and investment profile. However just to help ease you into the topics, here are some commonly-known ETFs for each asset class. We hope these can help you to connect the dots more easily later when you do your own research:
ETFs have become increasingly popular for the many advantages they offer. However, no investment is without risk and ETFs are no exception. To make sure that you maximize your returns with minimal risks, it’s important to have an ETF investment strategy in place that fits your needs.
For beginner investors, simple “buy and forget” strategies with monthly investments are more appropriate than the more complex strategies – make sure to read a beginner’s guide to the stock market before your start investing your money. More advanced investors might prefer leveraged ETFs or short-selling. The choice really depends on the investor, and it is also natural to evolve one’s investment style over time.
It is important to remember that it is not just about the ETFs you choose, but also when and why you buy them. Hence, having an ETF investment strategy should be a priority in order to manage your risks while getting the most out of this type of investment.
The 7 best ETF investment strategies
While there are as many ETF investment strategies as people investing in ETFs, here are the 7 best ETF investment strategies that are most commonly recommended by experts for all types of investors.
This strategy (also referred to as “buy and forget” is the best for beginners, as it focuses on the natural long-term increase in the value of the stock market. That means holding the assets for 10 years or longer. Broad market ETFs like the S&P500 ETF are amongst the best assets to invest in the long term, as historically they have outperformed most actively managed portfolios. They might sound safe, but they are definitely not boring: the Vanguard S&P 500 ETF (VOO) example has grown its market price by 216.35% cumulatively over the last 10 years.
2. Dollar-cost averaging
Investors who are making investments regularly (e.g., monthly, quarterly), can benefit from a potentially lower average cost over time, especially in bear markets. The reason for this is that through regular investments they will naturally buy shares at different entry prices, and hence can reduce the market risk of investing a huge lump sum when the price is very high. This together with the fact that it is an excellent strategy for putting monthly savings aside, makes this an excellent strategy for new investors.
For this strategy, the investor would bet on the prices going down in a bear market. They would borrow the shares of the securities they expect to fall and sell them in the open market. If the market indeed falls, the seller can buy the shares back for less money, with the delta being the profit of the trade. Inverse ETFs introduced before are used in this strategy, as it makes it easier and cheaper to execute compared to traditional stocks. While short-selling can be riskier and is advisable for experienced investors, it can be a great strategy for those wishing to hedge their risks (in a portfolio that otherwise bets on a bear market, e.g., equity ETFs). Hedging is in general an important strategy once the investment portfolio matures, for example when protecting overseas investment through currency investments to shield against currency risks.
Leveraged ETFs enable investors to increase their exposure, through borrowing money (the leverage). Classically various financial instruments such as options or contracts can be used. Leveraged ETFs make this process simpler, as they do not hold the securities found in the benchmark but rather amplify the returns thereof.
5. Thematic investing
Investors knowledgeable about a certain sector or technology might choose to invest in stocks and assets related to it. This can include for example High Tech or Biotechnology. The corresponding ETF includes stocks from this particular sector, thereby helping investors to focus their investments on the theme, without having to purchase individual stocks.
6. Sector rotation
For investors who want to increase their market exposure while still aiming to play it safe, sector rotation is an interesting strategy. Here the focus is on so-called sector ETFs. These 11 market sectors (e.g., technology, energy, healthcare) can be invested in similarly to thematic investing, however, the strategy here is to rotate them according to one’s belief which sectors will outperform the market for the time being. The investor will then “rotate” by selling the previous sector ETFs and investing in the next one.
7. Asset allocation
Any investment portfolio should be balanced and diversified to minimize risks. This is why it should include assets of different natures, such as stocks, bonds, cash, and commodities. With investment in a few ETFs, an investor can easily build a well-diversified portfolio, for example by combining a commodity ETF, an equity ETF, and a bond ETF.
ETFs offer a great way to diversify your investments and benefit from the most liquid assets in the market. Depending on your risk profile, you can choose the right ETF category that works for you.
There are many strategies out there like dollar-cost averaging or momentum investing that help minimize risks while still allowing for potential gains. If done correctly, ETFs can be a great way to build your investment portfolio.
Don’t forget that the earlier you invest in life, the more your investments accrue value over time: the time value of money teaches us that money today is worth more than the same amount in 10 or 20 years, as it can be invested and yield returns.
Ultimately independent of how you earn your money, ETFs are a great way of investing your money and it is critical to have the right strategy from the start. Be sure to look into all aspects of an ETF before investing in it and remember that no investment is risk-free.
Good luck on your journey!
The article includes the personal opinion of the author. It should not be considered Financial or Legal Advice. All data and numbers have been sourced at the 2023–03-28. Changes may apply.
Aaron is the founder of jiishinya. where he helps people independent of their gender, background, or education achieve success financially and privately.
He is very passionate about creating a secure financial future for himself and his family, and after starting at nothing, he is now able to invest a large portion of his monthly earned income into ETFs.
Disclosure: Some of the links in this article may be affiliate links, which can provide compensation to me at no cost to you if you decide to purchase a paid plan. These are products I’ve personally used and stand behind. This site is not intended to provide financial advice and is for entertainment only.