How ETFs can contribute to a long-term wealth strategy

As an investor, you are probably concerned about stock market volatility, rising interest rates and inflation. You may be looking for new investment options to diversify your portfolio. Most financial experts recommend a long-term investment strategy that generally rides out the ebbs and flows of the markets.

Why a long-term strategy?

“Investing can be a tricky game full of bull markets followed by bear markets and noisy short-term shifts in between,” said Bryan Armour, Morningstar’s director of passive strategies research for North America. “In my experience, investors make their worst decisions when reacting to this noise, making decisions based on emotions or fear of missing out. Short-term trading leads to classic investment pitfalls like chasing returns (i.e. buying the best) Attempting to profit by timing the market is a common mistake for retail investors and professionals alike.”

Additionally, Armor explained that long-term strategies set boundaries around trading and keep investors focused on their goals.

“The change in strategy along the way often happens at exactly the wrong time,” he continued. “Long-term strategies help investors stay on track with their investments and develop good habits, like saving. This can have a huge impact on long-term investors’ portfolios.”

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How does diversification help achieve this goal?

Armor maintains that diversification is a key part of long-term investing.

“It helps temper volatility and preserve capital so portfolios maintain long-term returns,” he said. “Making large bets on individual companies or a group of similar companies can carry a higher risk of a large loss which could set investors back from their targets.”

He said diversifying portfolios across different stocks and asset classes limits exposure to any risk factors and this approach reduces drawdowns and stabilizes the portfolio, allowing investors to continue to generate long-term returns. An exchange-traded fund, or ETF, which is a basket of securities or stocks, can play a role in diversification.

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How do ETFs contribute to this strategy?

Armor said ETFs aggregate holdings and provide diversified portfolios that reach into every corner of the market.

“Unlike mutual funds, there is no minimum investment required,” he said.

To that end, he said there are thousands of ETFs in the United States that cover virtually every asset class, from the S&P 500 to commodity futures, to hedge fund strategies, currencies and beyond.

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Advantages of ETFs

ETFs offer investors distinct advantages.

Cost

One of the biggest strengths of ETFs is their low cost, and Armor said their cost advantages manifest in several ways.

First, it stated that there are no charges or sales fees for selling your position in an ETF beyond brokerage fees.

“They also often have a lower expense ratio than mutual funds, allowing investors to keep more of their money for the long term,” he said.

Additionally, ETFs use creations and redemptions to add or remove shares of the ETF from the market, he said, often using in-kind transfers of holdings to avoid any taxable event.

“Mutual funds are often forced to buy and sell underlying securities to manage cash flows without the benefit of in-kind transfers,” Armor added. “This can significantly reduce capital gains distributions for ETF holders and improve tax efficiency in taxable accounts.”

It should also be noted that ETFs trade on exchanges that allow intraday trading, unlike mutual funds.

“The ETF wrapper is more flexible and transparent than traditional funds. Low costs and high transparency improve the predictability of ETFs, which enhances their appeal,” Armor continued.

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Diversification

Broadly diversified passive ETFs are a great entry point into the market and should be the cornerstone of any long-term portfolio, Armor said.

For example, a total US stock market ETF can give you access to thousands of US companies in a single fund and for a fee of just a few basis points, Armor said, according to the ETF.

“This maximizes diversification and the market value weighting ensures that the investor receives the overall return of the U.S. stock market over the long term,” he noted.

And, he said, the diversity of asset classes offered by ETFs makes it easy for investors to build a portfolio that meets their goals.

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How life goals play a role in your investment strategy

Your life goals certainly play a role in your investment decisions. Experts say having a plan in place can help achieve these goals.

Janel Jackson, global head of ETF capital markets and broker and index relations at Vanguard, said investors have the best chance of achieving their investment goals by developing an anchored strategic asset allocation over four key investment principles:

1) Set clear and appropriate investment goals.

2) Achieving balanced investments through a broadly diversified portfolio.

3) Minimize investment costs.

4) Maintain discipline over the long term.

EFTs can play a role in this strategy.

“Regardless of the phase of the investment lifespan – whether starting out, planning for a child’s education, or preparing for retirement – investors can build a portfolio with low cost and broadly diversified with Vanguard ETFs to achieve their investment objectives,” Jackson said. .

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