The role of ETFs in a balanced portfolio

Building a balanced investment portfolio is one of the most important steps to achieving financial stability and long-term growth. While traditional instruments such as stocks, bonds and mutual funds have long been popular among Indian investors, Exchange Traded Funds (ETFs) have emerged as an affordable and convenient investment option. When used in conjunction with other investments, ETFs can be a strategic way to balance and diversify your portfolio to reduce costs, mitigate risk and optimize return potential.

Let’s examine how ETFs can contribute to a balanced portfolio and how they are becoming increasingly popular among investors.

What are ETFs and how do they work?

ETFs, or exchange-traded funds, are a type of mutual fund that pools money from multiple investors to buy a basket of securities such as stocks, bonds or commodities. In contrast to mutual funds, ETFs are traded on the stock exchange like individual stocks. This means you can buy and sell them during market hours at current prices.

Each ETF usually tracks an underlying index such as Nifty 50, Sensex or specific sectors such as IT or healthcare. As the value of the underlying assets changes, the ETF’s value fluctuates proportionally, making it easy to understand and track.

How ETFs can help build a balanced portfolio

Building a balanced portfolio requires diversifying investments across different asset classes, regions and risk profiles. ETFs make this process easier thanks to their unique properties. This includes:

1. Diversification at low cost: ETFs offer instant diversification because they invest in a wide range of securities within an index. For example, investing in an ETF that tracks the Nifty 50 gives you access to the 50 largest companies in India without having to buy each stock individually. Additionally, ETFs generally have lower expense ratios compared to mutual funds, allowing you to save on fees in the long run.

2. Flexibility and Liquidity: Because ETFs are traded on exchanges, they typically offer high liquidity. Unlike mutual funds that require a net asset value calculation at the end of the day, you can easily buy or sell them during market hours. This flexibility makes ETFs suitable for both short-term and long-term investment strategies.

3. Transparency: ETFs are extremely transparent as their holdings are disclosed daily. This gives you a clear overview of what you are investing in and how your portfolio is performing.

4. Access to niche markets: ETFs allow you to invest in specific sectors, themes or regions that might otherwise be difficult to access. For example, you could invest in a gold ETF to gain exposure to gold prices or a global ETF to diversify internationally. These options make it easier to align your portfolio with your financial goals. Several index mutual funds also offer this advantage, and investors can choose which of the two paths is more suitable for them.

Building a portfolio with ETFs

When putting together a portfolio, it’s important to allocate your investments across different asset classes based on your risk tolerance and financial goals. ETFs can be part of a well-rounded portfolio that also includes active mutual funds that have the potential to deliver better than market returns in the long term, as well as stable avenues such as PPFs and fixed deposits, among others. Here are the different types of ETFs you can consider for your portfolio:

1. Stock ETFs for Growth Potential: Stock ETFs provide exposure to stock markets that have the potential for high growth over time. For Indian investors, options such as Nifty 50 ETFs or Sensex ETFs offer a cost-effective way to participate in the country’s best-performing companies. If you’re looking for more specific growth opportunities, sector-based ETFs like IT or Pharma can add targeted exposure to your portfolio.

2. Debt ETFs for Relative Stability: Debt ETFs invest in fixed income securities such as government bonds or corporate bonds and offer relative stability and the potential for regular income. They can be a suitable choice for conservative investors or those who want to reduce the overall volatility of their portfolio

3. Commodity ETFs for Hedging: Commodity ETFs, such as gold ETFs, can serve as a hedge against inflation and economic uncertainty. Gold has traditionally been a favorite of Indian households and gold ETFs offer an easy way to add this asset class to your portfolio without having to worry about storage or purity.

4. International ETFs for diversification: Global diversification is becoming increasingly important, especially for Indian investors looking to mitigate country-specific risks. With international ETFs you can invest in foreign markets such as the USA, Europe or emerging markets. For example, an ETF that tracks the Nasdaq 100 can give you exposure to leading global technology giants.

Such a balanced portfolio can potentially help you work toward your goals, such as retirement, more effectively. Once you retire, a systematic withdrawal plan (SWP) in mutual funds can potentially help you generate a steady stream of income from your capital built through mutual funds, ETFs or other investment options. An SWP allows you to withdraw a fixed amount from your investments at regular intervals. The amount remaining invested after each withdrawal continues to receive market exposure and may grow. This can help your corpus last longer than it would with a lump sum withdrawal. An SWP calculator can help you plan your withdrawal strategy.

Investments in mutual funds are subject to market risks. Please read all program-related documents carefully.