CEO of Austin Capital Trust
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AT FIRST GLANCE, building a broad-based,diversified portfolio with exchange-traded funds might look like a challenge. With more than 1,600 different products available at the click of a button, analysis paralysis can strike quickly. But there is a simpler way. Concentrating on funds that track broad market indexes can do a lot to clear the noise for the ETF markets and marketing.
Investors do favor a relatively small group of ETFs,most with simple investment strategies and broad reach. Many track indexes like the large-cap S&P 500 or the S&P Mid Cap 400, or aim for even broader exposure with a “total market” approach. Just 14% of funds account for 87% of the $2 trillion managed in ETFs, according to research and information provider ETF.com.
These broad funds come closest to the original goal of ETFs: attaining market-cap-weighted exposure to entire markets or giant chunks of markets at the lowest possible cost, eliminating the need for any market or valuation calls.
But investors now have a range of specialized ETFs to choose from-funds that track slivers of markets or that deviate from simple market-cap weighting in pursuit of higher returns. And those funds are attracting interest from investors.
There are a lot of marketing gimmicks and in many cases, investors are paying higher fees for specialized ETFs and ending up with lower returns than they can get with abroad fund with less reliable gains.
One exception to the broader-is-better approach is bonds. The broadest index funds are less likely to reward investors with what they are looking for in the fixed-income asset classes than in equities.
Diversification is tricky with bonds and mimicking the overall bond market doesn’t necessarily lower your overall risk, which is the primary reason most investors include bonds in their portfolios. That’s because the overall market includes bonds that carry significant credit risk, as well as bonds with longer maturities that leave investors more exposed to losses from changes in interest rates than shorter-term instruments do.
Targeted fixed-income funds give investors more control over those risks, allowing them to play it safe to balance their equities risk or take on some added fixed-income risk in an effort to boost returns.