Building the best ETF portfolio for retirement may differ in the details for individual investors, but the basic principles apply for all investors

We still feel that investors will profit the most with a well-balanced portfolio of high-quality individual stocks, but ETFs can also play a role in a retirement portfolio. Here are some tips on how to find the best-performing ETFs for maximum gains.

Broad exposure is key to creating the best ETF portfolio for retirement

With ETFs, investors get the broad market exposure of a traditional mutual fund at a lower cost than most mutual funds. The best ETFs also represent a low-cost, tax-efficient way for investors to make money in the long term.

Investors can buy ETFs on stock exchanges. Investors big and small can use ETFs to build well-diversified portfolios.

The best ETFs have low MERs (Management Expense Ratios). The MERs are generally much lower on ETFs than on conventional mutual funds. That’s because most ETFs take a much simpler approach to investing. Instead of actively managing their portfolios, ETF providers invest so as to mirror the holdings and performance of a particular stock-market index.

ETFs have evolved over the last few years, and competition has increased. At the same time, you need to be very selective with your ETF holdings.

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Diversification is essential for investors who want the best ETF portfolio for retirement

Diversification should be the focus for investors looking to build the best retirement portfolio. Tempering expectations on the size of your return is another important consideration as you plan for your retirement years.

Diversification is one of the most attractive features of ETFs. With an ETF, an investor is accessing all the stocks in an index.

When you buy individual stocks, your portfolio strategy should begin with one of the three key elements of our Successful Investor philosophy: Spread your money out across most if not all of the five main economic sectors (Finance, Utilities, Manufacturing, Resources, and Consumer). When you buy ETFs, you’ll also want to look at the sector balance of the stocks in the ETFs. That way, you can be sure that your overall ETF portfolio is also balanced.

If you diversify as we advise, you improve your chances of making money over long periods, no matter what happens in the market.

Four tips for building the best ETF portfolio for retirement

1. Know how broad the ETF’s holdings are. The more stocks it holds and the more it’s diversified across the five sectors, the less volatility it may have. For example, a sector-based ETF such as one that tracks resource stocks alone is likely more volatile.
2. Know the economic stability of countries that an international ETF invests in. It’s also good to mention that foreign leaders may not be your ally when it comes to passing legislation that can affect your investments.
3. Know the liquidity of ETFs you invest in—how many units a day it trades on average.
4. Consider buying ETFs in a lump sum rather than in periodic small amounts to cut down on brokerage fees.

The best ETF portfolio for retirement will avoid inverse ETFs

Inverse ETFs are set up to move in the opposite direction of particular stock indexes. An inverse ETF is designed to rise in value as the underlying market index falls: for example, if the index falls by 1%, the shares of the ETF should rise by 1% and so on. Also known as “short ETFs,” or “bear market ETFs,” they may appeal to some investors during volatile markets.

However, as a general rule, we advise against short selling just as we advise against options trading, leverage, currency speculation and bond trading. In all of these activities, it’s a rare investor who makes enough profit to compensate for the risk involved. Our view is that if you like the outlook for a market index, you should invest in stocks that will profit from a rise in that index.

Institutional investors, particularly hedge funds, sometimes carry out around 60% of all trading in leveraged and inverse-leveraged investments. They generally use them as part of complicated multi-investment trading gambits. They also trade frequently, and in large quantities. This reduces the percentage costs of this kind of trading. However, the trading costs still tend to eat up the invested capital.

One added concern is counterparty risk. That’s the chance the other party in a contract to repurchase securities will default on their obligations. Counterparty risk increases during times of extreme market volatility.

Inevitably, investments like these will go down more readily than they go up. That’s because investors have to absorb the costs of borrowing, entering into agreements with counterparties and so on, on top of the MERs.

We advise against investing in any of these ETFs.

Bonus tip: Key factors to consider when investing for retirement

1. How much you expect to save prior to retirement;
2. The return you expect on your savings;
3. How much of that return you’ll have left after taxes;
4. How much retirement income you’ll need once you’ve left the workforce.

Here’s another tip for something you should begin before you retire. Perform a detailed study of how you spend your money now. Then, analyze your findings to see what personal expenses you can cut or eliminate. This can help you determine how much money you need for retirement, and how to direct your investing. Note that this exercise can also have added benefits, especially if it helps you break unhealthy and expensive habits, like smoking.

What percentage of your portfolio is made of ETFs?