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The Best Exchange Traded Funds Investment Strategies

written by: Tim Plaehn•edited by: Doreen Martel•updated: 2/24/2011

Choosing exchange traded funds investment strategies is dependent on the investors goals and amount of analysis the investor is willing to do. Strategies can range from a simple, once a year re-balancing of a couple of ETFs to elaborate sector rotation programs.

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    Investing with ETFs

    The growth in exchange trade funds -- ETFs -- over the last 10 years the number of ETFs has increased from around 100 to over 1000 -- allows investors to set up a wide range of exchange traded funds investment strategies. Using ETFs to invest in the stock market eliminates the risk of owning a single stock that declines significantly or goes bankrupt, wiping out a chunk of your portfolio. Using ETFs also allows investors to diversify into other asset classes using the same brokerage account and paying the same level of commissions.

    The ETF infestment strategies here are focused on longer term investing, not short term trading. Investors should use the strategies outlined as guides to develop their own individualized strategies to use ETFs as the bricks of a long term portfolio building strategy.

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    Couch Potato Investment Strategy

    The Couch Potato investment strategy really exists and has been around since 1991. The strategy was conceived by Dallas Morning News financial columnist Scott Burns. It is called the couch potato strategy because you just need to get off the couch once a year to adjust your ETF portfolio.

    The couch potato strategy is to split your investment money 50/50 between an S&P 500 index ETF such as the SPDR S&P 500 fund, symbol SPY and a broad market bond fund such as the iShares Barclays Aggregate Bond Fund, symbol AGG. Once a year, added up the total values of the two funds in your account, add in the dividends that have been earned and sitting in the cash balance and divide by two. Invest the dividends and buy and/or sell fund shares to re-balance the two fund values to 50/50.

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    Asset Allocation Strategy

    Stock Market E-ticker An asset allocation strategy with ETFs takes the couch potato strategy and expands the number of funds and re-balance periods. To use asset allocation with ETFs pick a handful of funds that provide market exposure to asset classes significantly diversified from each other. Here is a list of possible fund types for an asset allocation strategy:

    • Broad U.S. stock market fund.
    • Foreign, established economy stock markets fund.
    • Emerging markets stock fund.
    • U.S. bond fund.
    • International bond fund.
    • Real estate fund.
    • Gold / silver / commodity fund.

    Design an allocation percentage for each fund and re-balance every three or six months. The asset allocation should allow you to have some money in the hot asset classes and end up with smooth portfolio growth over time.

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    Sector Rotation Strategy

    For the investor with analytical skills and knowledge of technical indicators, a stock rotation strategy can be implimented using ETFs. The producers of exchange traded funds have divided the stock market universe into a host of sector specific ETFs. Stock market sectors include companies in energy, technology, health care, consumer goods, heavy equipment and 30 or 40 more sectors if you want to carve the market in small enough portions. Investment advisors, New Arc Investments use 56 ETFs in their proprietary ETF sector rotation models. You can read about New Arc's strategies on the Dash of Insight blog.

    Investors considering a sector rotation strategy must find an analysis system that forecasts the future strong sectors and avoid chasing the current hot sectors. Research into the cycles of specific sectors in relation to the economic cycle is another possible approach. Investors using a sector rotation strategy for ETF investing must first find or develop a time system and then practice the discipline to follow the system.

    Exchange traded funds investment strategies can range from the simple buy and hold of a few well chosen funds to an active trading program to concentrate on hot sectors or funds.

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    Resources

    Sources:

    1. ETF Topics Couch Potato Portfolio
    2. Investopedia: ETF Investment Strategies
    3. Investor Guide: ETF Investing Styles

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