Diversification, core-satellite or portfolio rebalancing - discover the role ETFs can play in client portfolios.
ETFs are basically just another type of investment fund tracking a specific market index.
Importantly advisers do not need any special permissions from the Financial Services Authority to advise on ETF’s and their suitability for use by clients.
There are however some very important details and questions to think about.
Firstly it you’ll need to know whether the client wishes to invest a lump sum or to make many regular contributions.
ETFs generally have lower annual costs. However, since trading costs (such as stockbroker fees & bid-offer spreads) apply to each ETF trade, they are often more cost effective for clients making lump sum investments rather than regular small contributions.
Time also plays an important role.
You’ll also need to think about the investment time period, and thus calculating the “investment time horizon”. This is the length of time over which the total cost of investing in a mutual fund and an ETF becomes the same.
In the short term, trading charges can mean an ETF is less cost effective than a mutual fund, despite lower annual costs.”
The transaction amounts should be also be taken into account. As mentioned there are charges for each trade, and these are either charged as a percentage of the transaction or as a flat fee.
The size of the fee relative to the size of the trade will make ETF’s more or less attractive to clients
ETFs have many uses in client portfolios…
ETFs offer a diversified investment, with some even holding thousands of stocks. Thus a single investment offers instant diversification and thus reduced risk. A combination of ETF’s covering multiple markets can be used to build a diverse investment portfolio at low cost!
ETFs can be used in a core-satellite model portfolio. Diverse, broad market index ETF’s work well in the core, while specialist ETF’s can be used as satellite holdings.
ETFs can be used to complement an existing portfolio.
They may also be used to rebalance portfolios that are diverging from a client’s objectives. These imbalances can be corrected by purchasing the exact assets required (as in an ETF, even single shares can be purchased).