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Asset Classes Represented in ETFs

In order to make a diversified portfolio that will make up for the ups and downs of the market investors should carefully consider asset allocation. The latter represents the allocation of money among different types of securities and their proportion in the portfolio. However, most investors spend too much time on deciding exactly which stocks or bonds to include, but overlook their types.

However, in order to get a diversified portfolio you should pay special attention to the asset classes that are included. Many studies have proven that the success of a portfolio depends on the asset classes included not the individual stocks that are part of the investment portfolio. This is so, since if an individual stock, which is part of a particular asset class, performs well on the market, then the other stocks that are part of this asset class will also experience positive performance. You should have in mind that at times you may find it difficult to allocate your assets according to classes, but it is more rewarding than the individual picking of stocks.

Stock Picking Disadvantages

The major factor that contributes to the disadvantageous position of stock picking relates to the high competition on the market. Since stocks are very popular, much information is available to the general public, which leads to lack of access to unique information that may lead to one of a kind position. Insider information can put you in a better trading position than the other investors, but its usage is prohibited by law. Many investors tend to select stocks of companies that have not become widely well known yet. But, this strategy brings higher levels of risks as well. The history is full of examples in which stock picking has been successful in only separate occasions, and this success has rarely been consistent.

Asset allocation is in the heart of ETFs. The reason for this is that they include securities of almost all asset classes. They are also beneficial since they are inexpensive, have high degree of liquidity and are more reliable than most of the other investment tools. ETFs can be found in the following asset classes:

  • Small Cap Stocks - companies of the smallest size. They carry higher levels of risk in return to the higher profits one can acquire over the long term.
  • Mid Cap Stocks - companies of a medium size.
  • Large Cap Stocks - the largest companies operating on the market. They have high capitalization.
  • International Stocks - companies that operate outside the US border and are usually part of developed economies.
  • Emerging Market Stocks - companies that are part of emerging markets. They carry higher risk than other investments in return to the lower price per earnings. Many investors prefer them for the potentially higher growth in earnings.
  • Sector Stocks - groups of companies that operate within the same industry.
  • Growth Stocks - companies that have higher-than-average stock price-to-earnings ratio.
  • Value Stocks - companies that have lower-than-average stock price-to-earnings ratio.
  • Short-term Bonds
  • Mid-term Bonds
  • Long-term bonds - provide a guaranteed rate of return above a seven-year time period.
  • Real Estate Investment Trusts (REIT) - target commercial properties and invest largely in them. They are a great tool for achieving diversification since they don't move in the same direction as stocks.
  • Country

What investors actually look for is a consistent stream of earnings. Thus, they look at the growth/value indicator. Growth investors rely on the higher growth of growth stocks as compared to the company's peer from the same industry, which will result in lowering the initial price paid over the time. On the other hand, value stocks are selected with the hope that such stocks will have a lower growth. The latter will result in a smaller percentage of today's earnings being paid.

If you are looking for a guaranteed rate of return above a seven-year time period, then you should select long-term bonds. However, they carry a certain degree of the bond being depreciated because its interest rate is locked over the time period. On the other hand, this may be beneficial in times of falling interest rates. If you want to decrease interest sensitivity then you should select mid-term bonds. However, you should have in mind that they pay less than the long-term bonds. Completely insensitive to interest rate fluctuations are short-term bonds.  

Both governments and corporations can issue bonds. Government bonds are considered safest since they are backed by the viability of the US government, but they carry lower interest. State and city bonds have higher yields, but they come at higher risk levels as well.

All of these classes or a combination of them can be found in an ETF. However, you should have in mind that private firms are not included, but only publicly traded companies.

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