How to Construct an ETF Portfolio
Investing in exchange-traded funds (ETFs) has become increasingly popular among Australians looking for a cost-effective, diversified and accessible way to grow their wealth. Whether you're a seasoned investor or just starting your financial journey, constructing an ETF portfolio tailored to your goals is key to long-term success. In this guide, we’ll walk you through the steps to build a robust ETF portfolio that aligns with your investment objectives, risk tolerance and financial circumstances.
Firstly, what is an exchange-traded fund (ETF)?
It’s a type of investment fund that trades on stock exchanges, much like individual stocks. ETFs are designed to track the performance of an index, sector, commodity or other assets. They are a popular choice for investors because they combine the benefits of mutual funds (diversification) with the flexibility of stock trading.
For example:
Vanguard Australian Shares Index ETF (ASX: VAS)
This ETF tracks the performance of the S&P/ASX 300 Index, which represents the 300 largest companies on the Australian stock market.
When you buy a share of VAS, you’re essentially investing in a small piece of 300 Australian companies like BHP, Commonwealth Bank and Woolworths, all in one trade.
Instead of buying individual shares of all these companies (which can be expensive and time-consuming), you can gain broad exposure to the Australian stock market by owning this one ETF.
Step 1: Define Your Investment Goals
Before selecting any ETFs, it’s crucial to understand what you want to achieve with your investments. Are you saving for retirement, building wealth for a major purchase or seeking passive income? Your goals will influence the type of ETFs you select and the time horizon of your portfolio.
For example:
Retirement Savings: Focus on growth-oriented ETFs, such as broad-market equities.
Income Generation: Consider ETFs that offer dividends or fixed-income options.
Low Risk Investing: Prioritise low-volatility ETFs with minimal risk, such as bond or cash ETFs.
Step 2: Assess Your Risk Tolerance
Your risk tolerance determines how much volatility you can handle in your portfolio. A younger investor with decades until retirement might have a higher risk tolerance and invest heavily in equities, while someone nearing retirement might prefer a more conservative approach.
Ask yourself:
How would I react to a market downturn?
Can I afford to lose a portion of my capital in exchange for higher returns?
Do I prefer steady-predictable growth, over large gains?
Understanding your comfort level with risk will help you allocate your portfolio effectively across different asset classes.
Step 3: Choose Your Asset Allocation
Asset allocation refers to how you divide your investments among different asset classes, such as equities, bonds, property and cash. This decision is pivotal as it determines the majority of your portfolio’s performance.
Here are a few examples of asset allocations based on different risk profiles:
Conservative Portfolio:
10% Australian equities
5% International equities
5% Property
60% Bonds
20% Cash
Balanced Portfolio:
25% Australian equities
15% International equities
10% Property
40% Bonds
10% Cash
Growth Portfolio:
40% Australian equities
25% International equities
15% Property
15% Bonds
5% Cash
Step 4: Select the Right ETFs
With over 200 ETFs listed on the Australian Securities Exchange (ASX), choosing the right ones for your portfolio can be daunting. Focus on the following factors:
Asset Class Coverage: Ensure the ETFs you select align with your desired asset allocation. For instance:
Australian Equities: Look for ETFs that track the S&P/ASX 200 index.
International Equities: Consider ETFs that follow global indices like the MSCI World or S&P 500.
Fixed Income: Explore bond ETFs or those offering exposure to government or corporate debt.
Commodities: If diversification into commodities interests you, investigate gold or other commodity ETFs.
Fees and Costs: ETFs are known for their low fees, but costs can vary. Check the management expense ratio (MER).
Liquidity: Choose ETFs with high trading volumes to ensure ease of buying and selling. Liquidity minimises the risk of wide bid-ask spreads.
Performance History: While past performance doesn’t guarantee future returns, it’s still useful to review an ETF’s track record.
Step 5: Diversify Across Sectors and Regions
Diversification is key to reducing risk and improving long-term returns. Avoid concentrating your investments in a single sector, country or asset class. Instead, aim for broad exposure to different markets and industries.
For example:
Sector Diversification: Include ETFs covering technology, healthcare, financials and energy.
Geographic Diversification: Combine Australian equity ETFs with international options, such as U.S., European or emerging markets ETFs.
Step 6: Rebalance Your Portfolio Regularly
Over time, your portfolio’s asset allocation may drift due to market performance. Rebalancing involves realigning your portfolio to match your original allocation. This helps maintain your desired risk level and ensures you’re not overly exposed to any single asset class.
For example, if your growth portfolio’s Australian equities grow from 50% to 60%, you might sell some of these holdings and reinvest in bond ETFs to restore balance.
Step 7: Monitor Market Conditions and Adjust
While ETFs are designed for long-term investing, keeping an eye on market trends and economic conditions is crucial. Adjust your portfolio if:
Your financial goals change.
A specific sector or region becomes overvalued.
There are significant changes in your personal circumstances (job loss, inheritance, debt level change, children).
That said, avoid overreacting to short-term market volatility. Consistency and discipline are more important than timing the market.
Step 8: Understand the Tax Implications
In Australia, capital gains tax (CGT) applies when you sell ETFs for a profit. However, if you hold ETFs for more than 12 months, you may qualify for a 50% CGT discount. Additionally, some ETFs distribute income, which may be taxable.
To minimise tax liabilities:
Use franking credits from Australian equity ETFs to offset taxable income.
Consider investing through your superannuation fund, where tax rates are generally lower.
Consult a financial adviser or tax professional to optimise your tax strategy.
Step 9: Invest Consistently with Dollar-Cost Averaging
Dollar-cost averaging (DCA) involves investing a fixed amount regularly, regardless of market conditions. This strategy reduces the risk of buying at market peaks and helps smooth out the effects of volatility.
For example, instead of investing $12,000 in a lump sum, you could invest $1,000 monthly over a year. This approach ensures you buy more units when prices are low and fewer units when prices are high.
Step 10: Seek Professional Advice
Constructing an ETF portfolio can be daunting, therefore professional advice ensures your strategy is tailored to your unique circumstances. A financial adviser can:
Help you define clear goals.
Recommend suitable ETFs.
Provide insights into market trends.
Ensure your portfolio aligns with your broader financial plan.
Conclusion
Constructing an ETF portfolio is a practical way to achieve your financial goals while benefiting from diversification, low costs and accessibility. By following these steps, defining your goals, assessing risk, allocating assets, selecting ETFs, diversifying, rebalancing and seeking professional advice, you’ll be well on your way to building a portfolio that works for you.
Remember, investing is a journey that requires patience and discipline. With the right approach and support from Tanner Jordan Wealth, you can create a strong foundation for your financial future.
Comment from Tanner.
Investment Portfolio construction takes time, research, education and discipline. Financial markets don’t discriminate, they don’t care who you are, how much money you have or if you’re a good person. You need to have a strategy in place to mitigate risk and to capitalise on opportunities.
Seeking professional advice from a financial adviser will only help grow and protect your investment portfolio now and ongoing.