Use ETFs to manage time, effort and investments

Your investment process should be easy to implement and manage. That is, your life goals should not suffer due to your inability to find time each month to convert your savings into investments. How then should you plan your investments with minimal time and effort? In this article, we discuss how you can use equity exchange-traded funds (ETFs) to meet your life goals. This article can be read along with “Go for a small investment portfolio”— an article that appeared in this column dated November 11, 2012.

two portfolios

You should typically create two portfolios — core and satellite. The core portfolio is the primary component of your total investments. You should buy-and-hold your investments inside the core portfolio.

The core equity portfolio can be created by setting up a systematic monthly investment on a broader benchmark such as the S&P CNX 500 Index. As the market currently does not offer such products, your preferred choice should be the Nifty ETF. ETFs are open-ended funds, listed on the stock exchanges, which are created to mirror the index. Your monthly investment should be in a Nifty ETF of your choice, as all Nifty ETFs offer similar returns. Remember, investing in more than one Nifty ETF does not offer you diversification benefits.

If your monthly investment as part of your core portfolio is more than Rs 10,000 a month, you may want to consider investing on two different dates during the month — one day during the first week of the month and one day during the last week of the month. It is important to provide auto-debits from your bank account to invest in the ETF.

What happens if the market declines? You will be able to purchase more units with your monthly investment capital. But remember to reduce your systematic investments in equity as you approach your investment horizon to moderate the risk on your investment capital.

chart analysis

The attractiveness of ETFs is that you can use these funds as part of the satellite portfolio as well. How? Just as with your core portfolio, set up systematic investments every month on ETFs of your choice. The satellite investment is different in that you will continually take profits and reinvest the capital.

The preferred way is to trade on ETFs using chart analysis. Given your time constraint to follow market movements, you should frame easy-to-implement rules to manage your satellite portfolio. We suggest four simple rules to this effect.

One, set up your satellite portfolio with at least three ETFs — one gold ETF, one sector ETF and one thematic ETF. Stagger these investments through the month to get the satisfaction that you are continually investing in the market. Two, take profits when any of these investments has about 10 per cent returns or Rs 5,000 profits, whichever is lower. This is to ensure that you capture profits even if your initial investment capital is small. You can later change the rule to an absolute gain of Rs 10,000 or more. Three, preferably transfer the profits you generate from your satellite equity to your core bond investments. That way, you do not take additional risks on your equity investments. And four, keep at least 50 shares of any ETF on your portfolio even if your profit rule is triggered.

Least effort

You can effectively construct your equity portfolio using ETFs. Your choice of investments should span the suite of ETF products available in the market such as style ETFs (Nifty), sector ETFs (bank), commodity ETF (gold) and thematic ETFs (infrastructure). Your objective is to invest every month with the least effort. To this end, it is important that you keep the number of ETFs in your portfolio to 5 or less. And if possible, operate your core and satellite portfolios through separate demat accounts.

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