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What Is ETF Asset Allocation?

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  • Written By: A. Leverkuhn
  • Edited By: Andrew Jones
  • Last Modified Date: 24 November 2016
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ETF asset allocation involves considering how much of a given portfolio should be invested in exchange traded funds (ETFs), or how these instruments will help investors build more different kinds of stocks or other products into a “master plan” for capital allocation. As relatively new financial products, ETFs provide unique opportunities for returns on a range of investments, but as many financial advisers point out, asset allocation strategies can greatly improve reward to risk ratios for these types of investments. ETF asset allocation is part of a more global or universal strategy for asset allocation, which is often compared to the very different strategy of simply picking individual stocks.

Finance professionals stress the importance of asset allocation for many reasons. There is a growing consensus in some parts of the financial world that individual stock picking does not work well for most investors. Some of this is because of the complexity of research that is often needed. There are also a range of theories about the volatility and actions of individual stocks that have some investors looking for radically different ways to invest. Considering ETF asset allocation is one strategy for diversification, or putting a set amount of capital into different investments, in order to lower overall risk and provide more opportunity for gains.

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Using the term ETF asset allocation can be confusing. Asset allocation generally means diversifying money into different asset classes. ETFs can contain multiple asset classes, such as stocks or bonds with different market capitalizations. Finance professionals can also consider ETFs to be their own kind of asset class, where a balance between individual stocks and ETFs is a possible way to diversify a portfolio. In either case, the ETF can be a practical tool for more diverse asset allocation because these products include baskets of stock values that can produce more sophisticated gains.

Investors using ETFs can invest into two classic kinds of stocks, growth stocks and value stocks, that work differently. Growth stocks are stocks with explosive potential for gains. Value stocks are more established and stable stocks. Investors can also use ETF asset allocation strategies to get access to stocks in different sectors, or in different areas of the world. One example is the BRIC or developing country bloc, which includes stocks from China, India, Brazil and Russia.

Another benefit of using ETFs for asset allocation is that these financial products are fairly liquid. In other words, they can be easily bought or sold over online brokerage platforms. This can help investors to implement prudent profit taking, and sell ETFs when they have gained value. All of this contributes to the conventional knowledge about how ETF asset allocation can help individual investors.

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