Video Update: Pandemic Investing Via Sector ETFs
Today’s topic concerns a powerful investing tool that can turbocharge your retirement planning. It’s called tactical asset allocation (for a concise explanation, play my video below).
Rather than try to pinpoint individual companies in industries you think will pop when the coronavirus pandemic ends, exchange-traded funds (ETFs) are a potent means to that end.
During coronavirus-induced volatility, it’s increasingly important to pick your spots. Case in point: Goldman Sachs (NYSE: GS) on Monday sent a note to investors, warning that the U.S. recovery will run into a brick wall because of surging COVID-19 cases. The investment bank advised investors to start selling pricey stocks.
That’s when tactical asset allocation comes in handy. The goal of a tactical asset allocation strategy is to seize on fast-moving trends or to take advantage of any short-term view of the markets. This strategy is a nimble way to capitalize on rapid changes generated by the coronavirus pandemic.
Tactical asset allocation doesn’t involve day trading. It’s temporarily changing your mix of investments predicated on trends that you expect to unfold over the next three months to a year.
Once you’ve decided which industry to target, ETFs are a great way to accomplish your goal. You could, of course, buy individual stocks or bonds in the sector of the market that you think will perform well over the short term. To be sure, the team at Investing Daily firmly believes in active stock picking. But ETFs should be a part of your investment mix.
Simpler, safer, cheaper…
The drawback to betting on a sector via an individual stock is a lack of diversification. If you buy just one stock in the sector you expect to outperform, you shoulder the risk of being correct about the sector but unlucky with that specific stock. If you decide to seek diversification by selecting a basket of individual company stocks, commission costs can quickly escalate.
Using an ETF can be a simpler, safer and cheaper way to spread that risk out among several different companies. Mutual funds can accomplish tactical asset allocation, but your choices are more limited and you’ll incur higher management fees. If you have an investment goal, chances are good that an ETF exists that matches that idea.
Individual investors who want to profit from market trends but don’t envision themselves as stock-picking wizards can opt instead for an ETF. A major advantage of an ETF, compared to an index fund, is its stock-like features. Because ETFs trade on the market, you can execute with an ETF the same types of trades that you can with a stock (unlike an index fund). For example, you can sell short or impose a stop-loss order. In this sense, it’s less passive than an index fund.
ETFs first burst upon the scene in 1993 and they’ve become wildly popular. For starters, consider Select Sector SPDRs, which are targeted ETFs that divide the S&P 500 into 11 sector index funds (see the following infographic).
SPDR funds (pronounced “spider”) are a family of ETFs traded in the U.S., Europe, and Asia-Pacific and managed by State Street Global Advisors. SPDR means Standard and Poor’s Depository Receipt. But of course, SPDRs aren’t your only choices. There are now more than 2,000 ETFs tracking just about any asset imaginable.
Whichever ETF you choose, make sure its investment approach mirrors your tactical view. Read the ETF description and mission statement; look at the prospectus and examine the top 10 holdings. The ETF’s portfolio holdings should correspond with what you expect to happen in the market. Scrutinize the expense ratio.
For passive ETFs, the typical ratio is about 0.2%. That’s lower than the average expense ratio for actively managed mutual funds, which hovers between 0.5% and 1.0% and typically goes no higher than 2.5%, although some fund ratios have gone higher. Don’t overlook liquidity, either.
Several new ETFs come to market each month, and it can take time for them to create market awareness and build up enough volume to be reliably tradable. If you buy an ETF that lacks sufficient liquidity, your overall costs could be higher than you anticipate due to bid-ask spreads, or in the worst-case scenario, you might not be able to sell your shares when you want.
Do you have a well-reasoned expectation of what will happen next in the markets? Just as you can buy or sell stocks at any time during the trading day when the market is open, you can also buy or sell ETFs in exactly the same manner. Consequently, you can pursue your investment theme, and tactically change the asset structure of your portfolio, with the press of a button.
Three sectors appropriate for this strategy under current market conditions are utilities, health care and consumer staples. These three sectors provide essential services that people need regardless of economic ups and downs. This overbought stock market will soon collide with coronavirus realities, which makes these three defensive sectors smart bets now.
John Persinos is the editorial director of Investing Daily. You can reach him at: firstname.lastname@example.org