ETFs come in many shapes and forms. In fact, thousands of ETFs are listed on stock exchanges, running from equity Index tracking ETFs, which are the most popular, to commodity, Bond- and Treasury ETFs. Such examples include VUSA ETF, VWRL, VUKE, VWRA and ACWI ETF. There are even leveraged ETFs available for those who seek to enhance their returns (and their risk!).
But how can you best employ ETFs for a range of different investment strategies? We show you the ropes in our article!
1. Buy-and-hold investing
Buy-and-hold is a long-term investment strategy where you want to select a fixed portfolio allocation at the start and rarely, if ever change it. Hence, you should be looking to invest in ETFs which minimize fees and the tracking error compared to the relevant index and are highly liquid. So how to choose the right ETF for your buy-and-hold portfolio? Low-cost ETFs from large, well-known issuers such as Blackrock, Vanguard, SPDR and others are typically ideal.
2. Asset allocation
Asset allocation is a broad term for investing according to one’s risk tolerance, return objective and time horizon. An example is the so-called 60-40 portfolio. It is the opposite of trading or speculation and typically involves long-term thinking about one’s portfolio and how to slowly grow one's wealth.
Asset allocation involves spreading investments across different asset classes and hence ETFs are well suited to do this because they offer a wide range of options across various asset classes, including stocks, bonds, commodities, and real estate.
3. Thematic investing
When someone invests according to a theme or trend, this is called ‘thematic investing’. It means that the person believes to be able to generate excess returns by investing in companies which are riding on a trend, often growing significantly in the future. Examples of ‘thematic investing’ include topics such as tech, AI (artificial intelligence) but also niche trends like Cannabis and Cryptocurrencies. Thematic investing is a very risky investment strategy, as some trends turn out to be fads rather than trends and associated ETFs can lose nearly the entire capital.
Thematic ETFs come in all shapes and forms but are typically expensive, with fees often exceeding 1 per cent per annum.
4. Dollar-cost averaging
Dollar-cost averaging or DCA is an investment strategy that can be combined with any type of style, be it buy-and-hold, thematic investing, dividend investing or others. It simply involves buying a fixed dollar amount of an ETF at regular intervals, regardless of its price. Over time, this strategy can help mitigate the impact of volatility on the investment as you buy more shares when prices are low and fewer when prices are high.
Compared with directly investing in funds or single stocks, ETFs are particularly suited to this strategy due to their lower costs and ease of trading.
5. Dividend investing
For ETF dividend investing, ones that focus on dividend-paying stocks can be an excellent choice. These ETFs receive dividends from the companies whose stocks they hold and distribute them to investors either in cash or additional shares. Some ETFs, like the SPDR S&P Dividend ETF (SDY) and the Vanguard Dividend Appreciation ETF (VIG), specifically target companies with a history of increasing their dividends, providing a potential income stream for investors.
6. Swing trading
Swing trading is a trading strategy that aims to capture short-term gains over a period of a few days to weeks. Traders often use technical analysis or particular trading strategies such as momentum trading to find the right entry and exit points for their swing trades.
Normally, swing traders would directly trade single stocks or stock-index futures, however, broad index ETFs such as the QQQ (Invesco QQQ Trust), an ETF tracking the performance of the Nasdaq-100 Index, are also suitable for swing trading due to their high liquidity and tight spreads.
To pick the right ETF for swing trading, you should look for good trading volume and high-price activity. Once you've identified an opportunity, you can enter your position and set stop losses or take profit orders to automate the exit.
7. Leveraged trading
A number of instruments are available to traders to employ leverage in their trading strategies: most frequently used are futures, options and CFDs (contracts-for-difference).
However, leveraged ETFs have recently grown in popularity to employ leverage when trading single stocks. The reason for this is related to tight spreads on large-cap stocks such as Apple and Tesla and the embedded leverage of up to 3x.
For example, a 2x leveraged ETF seeks to deliver double the daily performance of the index it tracks. These ETFs are best used for intraday trading, where the added leverage can magnify gains (or losses). However, it's important to note that the performance of leveraged ETFs can significantly deviate from the underlying index over longer periods due to the effects of compounding.
From a trading perspective, short selling is risky: it involves borrowing stock with the idea to buy back the same shares later at a lower price, thus benefiting from a drop in the stock price. However, while stocks can only drop to zero, they can rise by much more than 100 per cent. Hence, brokers usually ask for a significant margin to back any short position in a single stock.
As a result, the ETF industry has designed special ETFs that enable short-selling directly embedded into an ETF product: for example, a 1x short ETF on a particular stock ETF then tracks the inverse performance of the underlying asset.