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ETFs Basics- Asset Allocation Models

By Rick Walter

If you have not reviewed the ETF basics posts, click the ETF Shelter labels and start from the beginning. Remember, as an investor you are purchasing ETF shares in the secondary market. You are not buying creation units or any of that. Of course at some point in time I would like to start an ETF Fund and you are welcome to join my fund, then we can all buy creation units and makes lots of money hedging. However we are not there yet.
Before you choose an ETF , you may want to start with some type of asset allocation model for yourself, which is the practice of dividing resources among different categories based on your risk tolerance, goals and investment horizon; Common classes for asset allocation models are Equities (stocks) , Fixed income (bonds), and Cash and cash equivalents (treasury securities); other classes of assets such as real estate are also included but can be defined in one of the three categories above.

Your asset allocation model should be built based on what you want your portfolio to do: Preservation of Capital, Income, a Balanced Approach, or Growth. Of course your AA Model will be diversified and it will have to be re-balanced from time to time as the market changes. Therefore your AA Model should be based on life questions such as planning for retirement, pending retirement, job promotion, new home purchase, tuition funding, purchasing a business, funding a pension or 401K liability and so forth.

Many investment and planning firms can really get technical and detailed about these categories. For example, each asset class can further be broken down into sectors. For instance, if we had chosen Income with some appreciation for growth then our portfolio based on our asset allocation model for income w/growth may look like this.



In example A, I would start start researching ETFs at the point where I decide to look for stocks in a particular sector, based on my asset allocation model. That's the goal of ETFs. ETFs allows you to target in on specific sectors and industries with precision but does not lock you into the investment with high management fees or penalties if you wanted to sell; ETFs gives you the flexibility you need to adjust or re-balance your portfolio if needed. ETFs gives you the diversification of a mutual fund more efficiently without over-diversifying, and indices that can be used for benchmarking your portfolio performances.

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