Investors are always asking for the makeup of the best long-term Australian ETF portfolio. The answer differs from person to person because of differences in individual risk appetite and investment horizon.
Is there a perfect ETF portfolio?
Exchange-traded funds allow investors to build an expanded portfolio in a quick and cost-efficient manner. Most ETFs are index funds that replicate the performance of a particular market. Owning a 2 ETF portfolio is equivalent to investing in 2 markets diversified across hundreds of stocks. To this end, the risk exposure of holding an ETF portfolio can be materially different from holding just two stocks.
Our list of ETFs on ASX shows almost unlimited combinations given the number of ETFs to create the best ETF portfolio. Especially individual circumstances will differ in every case.
We think the following tips outline a good starting point for those setting out to use the exchange-traded fund in their investment process.
1. Setup an ETF Portfolio Strategy
Before building a portfolio using ETFs, investors first need to develop a portfolio strategy, a road map for how they will achieve their financial goals. Effective strategies of portfolio management ensure that investment returns are commensurate with the individual’s risk tolerance.
There are several steps in developing the strategy. However, the goal is not to create comprehensive rules that cover every aspect of money management. Instead, it is a set of principles that outline the basic thesis and philosophy towards creating and managing assets. The principals are not something that is developed, fired and forget. It should be something that needs to be periodically reviewed and updated based on changing circumstances.
The key headlines in the ETF strategy will cover.
- The frequency in which the investment portfolio is rebalanced
- Will leverage be adopted?
- Income vs growth
- Liquidity – how often investment should be realized to fund retirement or lifestyle
- Market exposures – do you want just Australian shares or include international equities
These outlines will narrow down what you should or can invest in.
Exchange-traded funds provide one of the most cost-effective ways of gaining asset class exposure like shares or bonds and market exposure as they simply replicate a whole market’s performance like the FTSE 100.
2. Optimal Level of ETF Portfolio vs Other Assets
Portfolio allocation outlines the investment amount in shares, bonds or even real estate. ETF can be used as a means to achieve the level of desired portfolio allocation.
The benefit of adding ETFs to a portfolio is that it speeds up the investment deployment process and immediately provides diversification benefits due to each fund being itself a portfolio of assets. Therefore owning an ETF is already means your portfolio is partially diversified across a particular market.
- ETF allocation can be partial or in full if you don’t know anything about stocks. The portfolio can be made up of all ETFs if you are a novice and are worried about making mistakes that have long-term implications.
- If holding direct stocks is preferred (if you think you have an edge in picking stocks)
This implies that the overall portfolio will track the market’s performance at a low cost, ideal for investors with a long-term horizon. The only certainty in the market is uncertainty, and a diversified portfolio is one of the most important tents of investment management.
3. Create a Long Term ETF Portfolio for Australia only or adding some foreign exposure?
In our own portfolio, we have some market index funds that track the performance of the major markets like the ASX 100, which tracks the ASX top 100 stocks’ performance. But the overall weight of the Australia ETFs is small compared to our overseas portfolio.
Also, we like the offshore markets, especially the US market, with S&P 500 as a decent core holding.
The theme of domestic and international exposure can cut across asset classes. The big 4 banks dominate the Australian fixed income market, so retail investors have limited access to bonds or fixed income investments. We think this is one reason why mom and dads love investing in property, as it is one of the few avenues where investors can get exposure to a recurring income stream.
The resulting choices can determine if the portfolio is conservative or aggressive depending on the risk tolerance.
Bonus tip. Investment styles can also be separated into value shares or growth shares, providing a different set of market exposures.
4. Decide do you want capital growth or a recurring income stream?
We like capital growth, and our ETF portfolio leans towards growth shares and markets. Investors looking for a passive income stream can either own a portfolio of dividend stocks or Dividend ETFs.
The disadvantage of owning a portfolio of dividend stocks is you have to keep up with the market and rebalance the portfolio occasionally as conditions change. It is also important to avoid value traps as higher-yielding stocks typically result from share price sell-offs, and market expectation is the company will reduce the dividends in the future.
Owning a dividend ETF bypass some of these risks as it hands off the rebalance and stock selection to an index provider and the ETF manager, which will rebalance the portfolio according to its own rules.
5. Low-Cost ETF Portfolio should help but market exposure matter just as much.
Investors should always focus on the cost the fund managers charge in managing their assets. ETFs’ fees are so low these days that there are no real big differences between the big ETF providers like Vanguard or State Street.
Don’t get us wrong, we at Dividend Investing still think fees can make a large difference in long-term portfolios, but investors shouldn’t lose the forest for the trees. Over the long term, asset allocation and whether to invest in shares or bonds are just as important as choosing the lowest ETF option.
Summary
In sum, the above tips hopefully provide some guide to investors looking to create their own Australian ETF portfolio.