ETF Academy ETFs: An Ideal Investment Portfolio Construction Tool
ETFs are ideal for investment portfolio construction, especially for smaller individual investors seeking the advantages of large institutional investors.
Risk profile of an investment portfolio
When constructing an investment portfolio, your starting point is your risk appetite. How well would you sleep if your portfolio just lost 10% in a day? Would you remain invested if it dropped 40%? We typically work with three broad risk profiles, which match most investors:
- Low-risk profile
- Medium-risk profile
- High-risk profile
A balanced investment portfolio
You will find that ETFs have advantages when building a balanced investment portfolio. That’s because they’re already diversified across companies or governments, sectors and geographies. Then it’s up to you to determine the mix between ETFs, according to your risk profile.
The graph below shows the return of a 100% share/equity portfolio (dark blue line) and a 100% bond portfolio (light grey line). It then shows the effect of diversifying your investment portfolio to varying degrees across equity securities and bonds.
Performance chart of different strategies
Past performance is not a reliable indicator of future performance. Source: VanEck, Bloomberg. Data as of 30/6/2016 - 30/6/2021.
100% Equity Securities: consists of the Solactive Global Equity Index GTR;
100% Bonds: consists of the iBoxx Total Return € Liquid Sovereign Diversified 1-10 index;
Offensive Profile: consists of the Multi-Asset Growth Allocation Index;
Neutral Profile: consists of the Multi-Asset Balanced Allocation Index;
Defensive Profile: consists of the Multi-Asset Conservative Allocation Index.
The signature characteristics of each type of portfolio are evident. The investment portfolio with the largest bond holding (light grey line), the most defensive, does not depreciate as much in a falling market as the growth portfolio (cyan line). Yet, notably, the long-term return of the defensive portfolio is lower than that of a portfolio consisting entirely of equity securities.
Performance table of different strategies
|Portfolio||This Year||1 Year||3 Years (annualised)|
|100% Equity Securities||16.28%||32.07%||12.55%|
Source: VanEck. As of 30/6/2021.
It’s advisable to periodically rebalance your investment portfolio (perhaps once a year). This brings the weighting of your investment portfolio back to the intended mix shown above. Over time, balanced portfolios become skewed towards the type of investment that has performed best of all. For example, if the equity ETFs have risen sharply then their weighting will be higher. By selling some equity ETFs and buying fixed income ETFs, you bring the balance of your portfolio back into line.