Your portfolio has been developed to align with your risk tolerance and values. It may consist of exchange traded funds (ETFs), partially because they tend to be low-cost, but also because they can provide diversification and tax-efficiency.
For certain investors, it may have seemed like everything was humming along smoothly until the recent volatility in stocks such as GameStop (ticker: GME) triggered sizable swings in their portfolios.
While some investors were eager to own shares of so-called ” Reddit stocks” such as GME, others wanted no part of the Reddit rally. Unfortunately, their portfolios may have been exposed to GME as well.
This example highlights why it is essential to understand what is in your portfolio, even if it is primarily invested in passively managed funds. Understanding underlying fund holdings can help you avoid nasty surprises and approach your investing strategy with pride and ownership.
Passively Managed ETFs
Passively managed ETFs are rules-based, and the holdings typically reflect either an index that represents a particular theme or sector of the economy.
The XRT tracks the S&P Retail Select Industry Index while the RWJ tracks the S&P SmallCap 600 Revenue-Weighted Index, which weights stocks across various sectors by revenue. And investors who didn’t understand the underlying assets in those ETFs may have been surprised by their exposure to GameStop.
Investors seeking exposure to consumer-related stocks that may benefit from a cyclical rebound in the economy have many ETFs to choose from. An ETF that may gain from an increase in discretionary spending is the Consumer Discretionary Select Sector SPDR ETF ( XLY). The top holdings of XLY include Amazon ( AMZN), Tesla ( TSLA) and Home Depot ( HD).
These are companies with which you may be familiar and stocks that may not become “Reddit stocks.”
ETFs offer many benefits to investors, including diversification, low costs and tax efficiency.
An ETF can provide overall industry exposure, which is a benefit for investors seeking diversification.
Here’s an example of why diversification is important. Let’s say you want to own stocks that are developing vaccines in the fight against COVID-19. You may have thought that owning AstraZeneca ( AZN) over the past year would make sense, but it is currently trading near the same level that it opened for trade in 2020.
On the other hand, the iShares Nasdaq Biotechnology ETF ( IBB) has gained more than 30% since the start of last year.
Similarly, remember all that talk last year about the need to stock up on toiletries? If you had invested in CVS Health Corp. ( CVS), you may have lost money. It is currently trading lower than where it opened for trade in 2020. An investor would have been better off owning the Consumer Staples Select Sector SPDR ETF ( XLP), which has made gains since the start of 2020.
If you crave exposure to certain sectors that may benefit from developing trends, you may be better off owning ETFs that can provide exposure to a certain industry rather than owning a particular stock. This focus should help you gain a better understanding of what is in your portfolio.
[SEE: 9 Best Green Stocks to Buy.]
Know What you Own
Not only can your portfolio generate potential returns, it can align it with your values.
Responsible investing considers the environmental, social and governance, or ESG, impact of companies and can provide you with a sense of pride in your investments. Incorporating ESG criteria can motivate you to better understand what you own in your investment portfolio.
Identifying ETFs that invest in companies based on ESG metrics is increasingly manageable for investors. Many online tools, including As You Sow, offer research and scorecards on ETFs and mutual funds.
You should be thinking about your investment portfolios with pride. When asked about your portfolio, you should be able to provide an answer that does not just include risk and performance, but expresses satisfaction in what you own. Investigating and identifying ESG investments can help you achieve that pride and ownership.
Your portfolio should be working as hard as you do. Aligning it with your risk tolerance and your values is the first step in constructing a portfolio.
The holdings of your portfolio will ultimately determine the risk and volatility of what you own. Ensure that what you own is a fit for your portfolio and doesn’t add unnecessary volatility.
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