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In today’s highly volatile market, investors have to fine-tune their portfolios to decrease risk wherever they can. Investing in many different asset classes, also known as ‘diversification’, is the best way to mitigate risk and protect your wealth. Thankfully, exchange-traded funds (ETFs) exist, which allow investors to conveniently invest in a basket of diverse securities in a single package.
With stock market volatility hitting multi-year highs this spring, it’s important that investors minimize their exposure to risk. Although no stock is immune to risk, ETFs are one of the best options for cautious US equities investors who don’t have the time or expertise to pick-and-choose high-rewarding stocks. Instead, expert fund managers pick on your behalf.
ETFs 101: What You Need to Know
ETFs are the perfect investment for level-headed investors who understand that amateur-level analysis won’t provide the edge needed for generating higher risk-adjusted returns. Although investors can find success by picking and choosing stocks, there are ETF managers whose jobs are to find inefficiencies in the market and to constantly calibrate the fund to capitalize on them. In other words, fund managers work around the clock to help effectively manage risk for fund investors.
Since they were first introduced in the early 2000s, ETFs have helped many investors build an efficient and passive indexed portfolio. At a low cost, ETFs trade like a stock throughout the day but give investors exposure to a diverse range of stocks and other securities. They differ from mutual funds by offering lower expense ratios, on average, a less active management structure, and because mutual funds are only traded after markets close.
Why Invest in ETFs?
For one simple reason: diversification. If you invest in an ETF that tracks a broad section of the stock market, such as the Dow Jones Industrial Average, you put your “eggs” in a basket of stocks as opposed to a single company. Therefore, if certain stocks fall, your losses are shielded by other stocks which, presumably, have gained or held their value.
Another excellent reason for investing in ETFs is that they provide access to alternative assets such as real estate, precious metals, and currencies. Including these assets in your portfolio provides a hedge against inflation, stock market volatility, and some assets, such as gold, historically outperform the market during times of economic crisis.
My Top ETFs for 2020
This year has been marked by instability and volatility. For this reason, I’ve suggested a handful of low-volatility ETFs designed to help establish a more protective position for investors.
Utilities Select Sector SPDR Fund (XLU), 3.1%
With a 3.1% dividend yield, the Utilities Select Sector SPDR Fund provides significant market crash protection at a low expense (only 0.13%). Although you might hear about markets performing poorly or even crashing in the news, the utility sector (i.e., gas, water service, electricity, etc.) almost always experiences relatively low losses.
Investors look to utility sector indexes, such as the XLU, to protect their wealth when times are bad. This is a highly regulated sector with predictable profits and revenue streams that make it easy to gain access to a basket of 28 large, stable utility firms in the S&P 500.
Vanguard High Dividend Yield ETF (VYM), 3.9%
The Vanguard High Dividend Yield ETF (VYM) boasts a strong 3.9% dividend yield by tracking over 400 high-yielding mega-cap stocks on US exchanges. These stocks are generally concentrated in the utilities, energy, communications, and industrial sectors. At a low expense ratio of only 0.08%, the VYM is one of the cheapest options for acquiring a diversified yield that beats out just about any other stock ETF on the market.
iShares Cohen & Steers REIT ETF, 2.5%
As a real estate investment trust (REIT), the iShares Cohen & Steers ETF tracks an index dedicated solely to real estate securities. These include companies that own telecommunications infrastructure, logistics real estate, and industrial warehouses. Losses due to trade friction are also minimized by this ETF because most, if not all, companies held in this ETF operate entirely within the US.
iShares Select Dividend ETF (DVY), 5%
The iShares Select Dividend ETF (DVY) pursues a high dividend income for investors. This fund rivals the VYM fund by Vanguard but tracks a smaller assortment of 100 stocks on the Dow Jones with a five-year history of strong dividend growth, including Lockheed Martin, Caterpillar, and McDonald’s. Both VYM and DVY are excellent dividend-oriented ETF holdings that have little overlap between them.
JPMorgan Diversified Return International Equity ETF (JPIN), 3.7%
Last, I recommend the JPMorgan Diversified Return International Equity ETF (JPIN), simply because it seeks exposure to diversified stocks across four global regions and ten sectors outside of North American markets. Its holdings are primarily concentrated in value-oriented international equities in pharmaceuticals, agriculture, and entertainment.
The Bottom Line
ETFs spread your wealth across a diverse range of US and international equities, which allows investors to mitigate risk while enjoying relatively high dividend yields and long-term returns. Since they’re actively managed by professional analysts, they also take a lot of leg work out of stock market investing.
However, no investor should have an all-ETF portfolio. In 2020, I recommend hedging against stock market volatility by supplementing your IRA or 401(k) with not only ETFs but also precious metals, physical real estate, as well as fixed-income securities such as U.S. Treasury notes and bonds to effectively manage risk—this way, if a particular ETF crashes, your losses will be offset by other holdings that perform comparatively well.
For more information about how you can diversify beyond equity investing, check out our gold IRA comparison guide as well as our reviews of some of the best precious metals custodians, such as Equity Institutional and GoldStar Trust Company.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.