When trading the markets, there are many financial products available to choose from. ETFs give investors the opportunity to use single instrument to invest in many securities in one transaction.
ETF trading has increased rapidly since 2007 with investors’ growing interest in fixed income funds and exposure to emerging markets. They are therefore becoming increasingly popular products, offered by many reliable and popular brokers.
What is an ETF?
ETF stands for Exchanged Traded Funds. This instrument is essentially a basket of assets that monitor the performance of the benchmark index to which it relates, so an ETF generally represents a fraction of this index. Therefore, an ETF is like a listed index fund that replicates the performance of a benchmark index that can be:
another index such as the Dow Jones or the S&P 500 in the United States
a business sector such as technology or financial stocks
a commodity such as precious metals or oil
a crypto-asset such as Bitcoin or Ethereum
a fixed-income product such as bonds
ETFs are a great way to diversify your investment portfolio
Diversifying your portfolio is essential to trading success.
This does not mean holding a large number of assets, but having them spread across different asset classes or sectors. The aim is to minimize idiosyncratic risk, which is the specific or unsystematic risk that affects only a handful of assets.
Diversification is also about preserving your trading capital. To allocate your money so as to best protect it, you want to avoid overexposure to a particular sector or a specific geographical area. ETFs can help you in that diversification process.
Always remember not to “put all your eggs in one basket”
You can use ETFs to target different geographical areas. You can use them to diversify your portfolio according to different asset classes. You can also invest in Blue Chips (large companies) or Small-Caps (companies with small market capitalizations).
Now that you understand more about how ETFs are useful trading products for portfolio diversification, instead of selecting about 40 different actions, you can simply select several ETFs since each contains many securities. The idiosyncratic risk you face will therefore be reduced.
However, it is important that your choice of ETFs reflects your investment strategy. You should always think about your investment objectives, your time horizon and your degree of risk aversion. In short: determine your investor profile first and foremost!