Investors looking for risk reduction, diversification and better returns in the long term should consider investing in Exchange-Traded Funds (ETFs). Having a diverse investment portfolio would mean that the overall risks are spread across varying asset classes, thereby effectively reducing the risk. As Kavan Choksi / カヴァン・チョクシ points out, ETFs can be considered to be a ‘basket of securities’ that contains asset classes like commodities, bonds, company stocks, and more. Hence, buying an ETF would make an investment portfolio more diversified.
Kavan Choksi / カヴァン・チョクシTalks About Leveraging ETFs For Diversification
ETFs or Exchange-Traded Funds are investment funds that trade on the stock exchange and represent ownership of a diversified set of underlying assets, like commodities, bonds, stocks, particular sectors or even entire indices. The structure of ETFs is the key aspect that sets them apart from other investment instruments, as each of them comprises a portfolio of underlying assets that reflect a particular index or investment strategy. An ETF tracking the S&P 500 index, for instance, shall comprise of a selection of the stocks that make up that index, and its performance would largely mirror that of the S&P 500 as a whole.
The wide range of assets that an ETF can be exposed to facilitates extensive diversification. Multiple strategies can be implemented to enhance diversification and reduce risks through ETFs.
- Portfolio diversification: The impact of poor performance in a specific investment shall be mitigated when assets are distributed across different classes, geographic regions and industrial sectors. Investing in ETFs is a simple yet effective way to achieve this diversification. It enables portfolio managers to seamlessly adjust their portfolios based on their economic expectations as well as opinions on varying sectors.
- Asset diversification: Concentrating an investment portfolio on a single asset or a small group of assets would expose it to considerable risk. ETFs make it easy for asset managers to effectively build their investment strategy with an expansive range of asset classes without having to individually buy and manage them. One may choose to invest in ETFs that are equity indices, commodities, real estate, corporate bonds or government bonds, among others, based on their investment goals. This asset diversification can be useful in lowering risks, as investing in an ETF that covers several assets within a category would help dilute the impact of poor performance by a single asset, making it easier to reduce the overall portfolio risk.
- Industrial sector diversification: Sector-specific ETFs focus on particular segments of the economy, like finance, energy, healthcare and technology. Adding ETFs from varied sectors to the portfolio would be a good idea, as doing so can reduce exposure to specific risks in a given industry.
- Geographic diversification: Regional and global ETFs provide exposure to diverse geographic regions and markets, which is important for lowering the dependence on a single market and seizing opportunities worldwide. ETFs tracking indices of emerging and developed markets are among the most common examples of this strategy.
As Kavan Choksi / カヴァン・チョクシ points out, opposed to traditional mutual funds, ETFs are traded on the stock exchange much like individual stocks. Hence, investors enjoy the freedom to buy and sell off ETFs at any time during the trading hours in the market, much like ordinary shares.
