Where ETFs can fit in an overall investing approach

Key takeaways:

• ETFs have continued to grow in popularity, offering investors a flexible, cost-effective way to help diversify and align their portfolios with specific goals.
• Recent trends, such as the rise of actively managed and thematic ETFs, are giving investors new tools to adapt to market dynamics.
• ETFs remain a valuable option for tax efficiency, model portfolios, and accessing specific sectors or asset classes.

ETFs have become an integral part of modern investing strategies. This success isn’t a surprise because ETFs have a lot going for them: lower costs compared to most mutual funds¹, portfolio transparency², and the ability to buy and sell them during the trading day (daily liquidity).³

These features can make them an attractive option for investors with different goals, portfolio sizes, and profiles. Whether investors are taking a long-term approach or seeking tactical exposure, chances are ETFs can complement an overall approach.

1. Diversification and targeted exposures

ETFs may provide diversification across a broad range of securities, helping to spread risk. They can track entire indices, like the Nasdaq-100® Index, or focus on specific sectors, asset classes, countries, or geographical regions. In today’s market, investors are increasingly using thematic ETFs to access emerging trends such as clean energy, artificial intelligence (AI), and blockchain technologies. These targeted exposures may allow investors to balance broad diversification with opportunities for potential growth.

2. Getting sector exposure

Some investors use sector ETFs to gain exposure to entire industries rather than researching and purchasing individual stocks. One potential drawback of picking an individual stock is that it may underperform its industry.

ETFs can make it simple to invest in entire specific sectors, whether investors are interested in technology, healthcare, or consumer discretionary. By selecting sector ETFs, investors can seek to take advantage of growth opportunities while staying nimble as market trends shift. For example, industry-specific ETFs have helped make it easier to implement so-called sector rotation strategies that favor specific sector ETFs that may perform better due to the current phase of the economic cycle.

3. Implementing core-satellite approaches

The core-satellite approach remains a popular strategy for helping balance stability and growth. A core investment in broad market ETFs can provide potential stability, while satellite positions in sector- or thematic ETFs may offer growth potential. Incorporating actively managed ETFs into a satellite strategy has become increasingly popular, as these funds offer the potential for outperformance while still retaining the transparency and liquidity of ETFs.

4. Potentially limiting taxes

ETFs are known for their tax efficiency, a benefit of their unique “in-kind” creation and redemption process. This structure helps minimize taxable events, making ETFs a good choice for long-term, tax-conscious investors. In 2023, 60% of U.S. equity mutual funds paid capital gains distributions to their shareholders.⁴ On the other hand, in 2023, only 40, or 2%, of Invesco’s ETFs, distributed capital gains for one of the lowest percentages in the industry.⁵ In short, the inner workings of ETFs may help limit the capital gains taxes that investors have to pay every year. ETFs are also a popular instrument in tax-loss harvesting strategies that can potentially lower tax bills by taking advantage of losses in a portfolio and offsetting gains.

5. Building model portfolios

ETFs are popular building blocks in many model portfolios, helping provide a cost-effective and flexible way for financial professionals and investors to implement diversified strategies. Model portfolios are often built around specific goals, like income generation, growth, or risk management. The growth of digital platforms and robo-advisors has made ETF-based model portfolios more accessible, allowing investors to automate and optimize their portfolio allocations.

ETFs remain relevant in a changing market

The role of ETFs in an overall investing approach continues to expand as market conditions evolve. Over the past year, trends such as the rise of actively managed ETFs, thematic investing, and option-based strategies have reshaped the ETF landscape. Investors have been increasingly turning to these tools to help mitigate volatility, capture growth opportunities, and navigate inflationary environments.

From helping to provide instant diversification to offering tax efficiency and sector exposure, ETFs remain an essential building block for many modern portfolios.

ETFs like Invesco QQQ, which tracks the Nasdaq-100 Index, can help investors pursue their goals with precision, cost-effectiveness, and flexibility.