ETFs are great for diversification, but check their holdings carefully

Financial experts say allocating an entire portfolio to ETFs can be a viable strategy, but it’s important for investors to know what holdings are in the funds they’re buying.

When looking at portfolio diversification for ETF-focused investors, Jonathan Rivard, general principal at Edward Jones, said it’s important to consider the individual’s time horizon and risk appetite.

“You could absolutely be 100% invested in ETFs. But you want to know what’s in the ETF and what the allocation looks like. Some ETFs will be balanced; they’ll have a mix of stocks and bonds in them. Some will be sector products,” Rivard said. “The important thing comes down to understanding what does this basket hold? And if I own multiple ETFs, what does it look like across multiple ETFs in terms of asset allocation?”

Diversify asset types, not just geography

Prerna Mathews, Mackenzie Investments’ vice-president of ETF product strategy, said there are a few key points to keep in mind regarding diversification, notably, it is important to think beyond just diversifying by geography.

“So (if) you’re starting with the core Canadian, U.S., international exposure, don’t stop there. Think about how fixed income plays a role in your portfolio, real assets, there are thematic products, and there are alternative ETFs. There are a lot of different drivers of return that can be added to a portfolio available in ETF form,” she said.

Another consideration is buying ETFs with different investment styles, she said, which may include combining traditional index ETFs with others that are actively managed or have low volatility.

Time horizon is also an important consideration, where those with a longer investment horizon may want to focus on growth, she said, taking on more risk with higher equity exposure.

Regarding fixed income, Mathews said to be aware of the differences between short- and longer-term yields, adding that most investors will likely not have exposure to every duration of fixed income and should know the relevant trade-offs.