Originally published at: How to build a portfolio using ETFs – InvestEngine Insights
Want to learn how to build a low cost, diversified ETF portfolio? Discover how to set your goals, manage risk, and choose equity, bond, and thematic ETFs here.
So you’ve done the hard part, which is deciding to start your investing journey and taking the first step of opening an InvestEngine DIY account.
Now, it’s time to build your portfolio using ETFs – but this needn’t be as complicated as personal wealth gurus make it out to be. In this blog post, we’ll guide you through building your portfolio.
Why invest in ETFs?
ETFs (exchange traded funds) are funds you can buy and sell on the stock market, similar to shares. Each ETF holds a mix of investments (including stocks, bonds or commodities) which makes them a simple way to build a diversified portfolio. Some ETFs are passive, meaning they try to copy the performance of an index like the FTSE 100 or S&P 500. Some ETFs are active, meaning a fund manager picks the investments in an effort to beat the market, rather than just track it.
You can access thousands of investments grouped by asset type, region, industry and theme whilst benefiting from typically low fees.
If you don’t have niche industry expertise or the time to research and pick individual stocks, ETFs may be the way to go.
How to set investment goals for your ETF portfolio
There’s no one-size-fits-all approach when it comes to building your investments.
With InvestEngine’s DIY portfolio you can tailor your holdings to suit you. Details about the specific holdings, regions and industries each fund invests in are easy to find, making it simple to see exactly what you’re investing in.
First, decide what’s important to you.
Are you interested in certain countries or continents? Do you stay up to date with the latest tech start ups or keep an eye on big pharma? Is a company’s dedication to reducing their carbon footprint important to you?
Next, think about how long you want to stay invested for – and what your appetite for risk is.
Do you want to buy a house in 5 years’ time? Are you building a nest egg for your children to help with university or as a house deposit? Or do you want to retire early?
Knowing how long you want or need to stay invested can help you decide how much risk you’re comfortable with. Each ETF on the InvestEngine platform comes with a Key Information document where you can see the risk rating from one to seven (seven being the riskiest).
If you’re not comfortable making these decisions yourself, we would always recommend getting some expert advice from a financial adviser.
The importance of diversification
It’s vital to make sure your portfolio is well-diversified. As InvestEngine only offers ETFs, you’re already halfway there as you should never invest all of your money into a single stock. Still, it’s important to do your own research and make sure the ETFs you choose aren’t restricted to one region or sector.
Simply put, diversification is when your eggs aren’t in one basket. After deciding what’s important to you, it’s recommended that the ETFs you choose fit your circumstances and give you access to a wide range of investments in the market.
What is pound-cost averaging?
Pound-cost averaging is a strategy where you invest the same amount of money at regular intervals regardless of what the market is doing instead of trying to time the market. Over time, this helps to smooth out the average cost of your investments.
InvestEngine offers weekly, fortnightly and monthly savings plans that will autoinvest your cash for you, removing any emotion or sudden decisions when investing. However, it’s worth checking if your bank offers variable recurring payments (VRPs) that facilitate these payments.
How to choose your ETF asset allocation
There are three main types of asset classes to consider when building your InvestEngine portfolio: equities, bonds and commodities.
Most people choose a split between equities and bonds. This ratio can always be altered depending on your appetite for risk. With our rebalancing feature, you can easily readjust.
Equities are shares in a company, which means you own a small part of it. Their value can go up and down, so they’re usually more risky.
Bonds are loans you give to a government or company. In return, you get regular interest payments and your money back at the end of the term. They’re usually lower risk because the payments are predictable.
Commodities are investments based on physical goods like gold, silver, oil or raw materials. You can invest in them through ETFs that track specific sectors like mining. Their prices can still rise or fall, but they can help protect your portfolio during inflation or economic uncertainty.
How to pick your equity ETFs
Now you’re ready to choose a few ETFs for your portfolio.
First, look for an equity ETF to build the core of your portfolio. Consider one that tracks a major global index, then try to add in other asset classes like bonds to suit your individual risk profile.
The risk is reduced with an all world fund as you’ll be exposed to many regions and sectors, so if one type of investment isn’t performing as well as you’d like, the effect is negated by one that is doing well.
How to pick your bond ETFs
Your core holdings don’t have to only be in equities – there are bond ETFs too.
Bond ETFs can make your portfolio more stable and pay regular interest.
Some bonds are linked to inflation, helping your money keep its value over time. Bond ETFs also spread your risk by holding many bonds at once, so you get instant diversification with a single investment.
Choosing satellite or thematic ETFs
For those of you with niche interest areas, this can be the fun part. Satellite or thematic ETFs range from physical commodities (tangible goods like gold, oil or metals), country-specific ETFs or those that deal with specific sectors. A common approach would be to think about the products, brands or sectors that you think are likely to perform well in the future, and pick ETFs that align with them.
If you believe AI is the future, think about adding a robotics or artificial intelligence ETF to your portfolio.
InvestEngine also gives you the opportunity to filter for ESG (Environmental, Social and Governance) screened ETFs, so you can invest in companies involved in clean energy or gender equality, for example.
We can’t tell you what to invest in – but whatever you do choose, make sure you’ve done your homework and feel comfortable that these are areas that are likely to see long term growth. If you’re not sure you’re making the right decision, get some expert advice.
Rebalancing and monitoring your ETF portfolio
One of the best qualities of ETFs is that you don’t have to constantly check your account to make trades and track performance.
However, it is important to keep your asset ratios in line with long term goals. You should monitor and rebalance your portfolio periodically.
Rebalancing means checking your investments from time to time and adjusting them to stay on track with your plan. For example, if your shares grow faster than your bonds, your portfolio might become too risky. Rebalancing helps you bring things back to your original mix, so your risk level stays where you want it.
Lastly, don’t panic when the market is underperforming. Keeping your long term time horizon in mind. Do your research – but staying the course and remaining invested is often key to riding out any market turbulence.
Conclusion
Let’s recap the steps to building an ETF portfolio:
- Set your goals – which will help you decide on your risk tolerance and time horizon.
- Understand the importance of diversification.
- Decide on your asset allocation and what ratio of equities, bonds and commodities you’re comfortable with.
- Pick your equity ETFs, bond ETFs and satellite/thematic positions.
- Decide on how regularly you want to invest.
- Monitor and rebalance your portfolio at least once a year.
Frequently asked questions
- What are ETFs and how do they work? Exchange traded funds are investment funds that hold a collection of assets such as stocks, bonds, or commodities. They are traded on stock exchanges in the same way individual stocks are.
- Why should I build a portfolio using ETFs instead of individual stocks or mutual funds? Diversification is key – you’ll get exposure to many securities in one fund, expect lower fees than most active mutual funds, increased flexibility (because they can be traded throughout the day on a stock exchange) and more transparency as holdings are usually disclosed daily.
- How many ETFs should I hold in my portfolio? Many people opt for three to five ETFs, as too many may overcomplicate your strategy. Always do your research, and if in doubt ask an expert for advice.
- How often should I rebalance my ETF portfolio? Once or twice a year should be enough. Check your portfolio when your long-term goals or current circumstances change.
Important information
Capital at risk. The value of your portfolio with InvestEngine can go down as well as up and you may get back less than you invest. ETF costs also apply.
This communication is provided for general information only and should not be construed as advice. If in doubt you may wish to consult a professional adviser for guidance.