10 ETF Investment Strategies (and How They Work)

There are thousands of ETFs in dozens of different categories investors can use for a range of investing styles. From dollar-cost averaging to dividend investing to hedging, there are ETF investment strategies for all types of investors. 

Learn more about ETFs and how they can be used in 10 different investment strategies.

10 ETF Investment Strategies 

With so many different types of ETFs on the market to choose from, investors of all kinds have tools available to them to implement investment strategies unique to their goals.

For example, ETF investment strategies include: 

1. Buy-and-hold investing 
2. Dollar-cost averaging 
3. Asset allocation 
4. Sector rotation 
5. Swing trading 
6. Leveraging
7. Short-selling 
8. Hedging
9. Dividend investing 
10. Thematic investing

Buy-and-Hold Investing 

As the name suggests, a buy-and-hold investment strategy entails buying investment securities and holding them for the long term, which is generally assumed to be a period of 10 years or longer. Because of their low costs, diversification, and variety of choice, ETFs are among the best long-term investments on the market today. 

A popular long-term investing strategy is to buy and hold index funds with low expense ratios. The reason for this is that a broad market index fund, such as an S&P 500 ETF, has historically outperformed most actively managed portfolios for periods of 10 years or more.

Generally, when comparing funds that track the same index, the one with the lowest expense ratio has the best performance over time. Since ETF fees are often lower than most mutual funds, they fit well into this buy-and-hold approach. 

Dollar-Cost Averaging 

ETFs can work well in a dollar-cost averaging (DCA) strategy, where an investor can make purchases at regular intervals, rather than in a lump sum. A DCA strategy can reduce market risk because the periodic purchases buy shares at different entry prices, which can lower the average cost over time, especially in a bear market when prices are falling. 

A DCA approach can be accomplished easily through an automated investment program. Some discount brokers offer certain ETFs at zero commission, which helps to lower the cost of investing, especially when purchases are being made at regular intervals, such as monthly. 

Asset Allocation 

When building a portfolio, the foundation is built with asset allocation, which is an investor’s chosen mix of investment assets, such as stocks, bonds, cash and commodities. With multiple low-cost choices within all asset types, ETFs can be the building blocks of a diversified portfolio. 

For example, with just three ETFs, an investor could cover the entire U.S. stock market, the entire U.S. bond market, and a broad basket of commodities in one portfolio. 

For more detail on asset allocation and choosing ETFs, look at our article on how to choose the best ETFs for long-term investing.

Sector Rotation 

For more advanced investors, sector ETFs can provide an effective way to move in and out of any of the 11 market sectors, including health care, technology, financials, energy and more. With sector rotation, an investor may choose to allocate a portion of their portfolio to sectors they believe can outperform the market, then “rotate” by selling those respective sector ETFs and buying others. 

For example, if an investor believes a certain sector within their portfolio is becoming overpriced as a whole, they may choose to sell that respective sector ETF and buy into another sector ETF they believed would outperform in the coming cycle.

Since sector ETFs can track the performance of an index of securities that may represent an entire market sector, investors can easily implement and manage a sector rotation strategy. 

Swing Trading 

Swing trading is a strategy wherein an investor attempts to profit from a stock’s or ETF’s recent price momentum and anticipated short-term gains. The holding period for swing trades is generally longer than a day and up to a few months. Swing traders often use widely traded stocks or ETFs, which tend to have more predictable trading patterns than less-traded securities. 

Leveraging 

A leveraging investment strategy may use borrowed money, which is also called leverage, to amplify the short-term returns of an investment. To achieve this strategy, an investor may use various financial instruments or derivatives, such as options contracts. Making the process simpler, an investor may simply purchase leveraged ETFs. 

Leveraged ETFs don’t hold the securities found in a benchmark but will use financial leverage to amplify the returns of the benchmark. For example, a traditional ETF that tracks the S&P 500 will seek to match the index returns on a 1:1 basis by holding the securities in the index. However, a leveraged ETF may seek to produce returns at a 2:1 or 3:1 ratio, double or triple the returns, respectively. 

Short-Selling 

In a short-selling strategy, or to “sell short,” an investor who expects the price of a security to fall borrows shares of the security and sells the shares in the open market. If the price falls, the short-seller can buy the shares back for less money, thereby profiting from the trade. Securities most often used by short-sellers are stocks and ETFs. 

Instead of short-selling a stock or ETF, investors may also use inverse ETFs, which can be easier and cheaper than traditional short-selling. Like short-selling, inverse ETFs allow investors to make bets that a benchmark ETF will decline without having to directly purchase derivatives.

For example, an inverse ETF can produce returns in the opposite direction of a benchmark index. So, for a 2x inverse ETF, the daily return would be 2% if the benchmark index had a daily return of -1%. But investors should keep in mind that a positive return on the benchmark would produce negative returns on the inverse ETF. 

Hedging 

A hedging strategy involves buying or selling an investment security to help offset the potential decline in value of another asset or security. For example, an investor who holds a large long-term position in stocks may sell a stock ETF short, or buy inverse ETFs, which will produce a positive return if the long stock positions fall in price. 

Other forms of a hedging strategy may involve buying certain investments that can offset the risk of a particular economic environment. For example, an investor may choose to add ETFs for inflation, such as a TIPS ETF or a commodity ETF, that have historically performed better than the broader market during periods of high and rising inflation.

Dividend Investing 

Many investors choose to buy dividend ETFs to achieve an income strategy or as a means of holding a basket of quality stocks for long-term appreciation. Rather than doing research and analysis to find dividend stocks, an investor can simply buy a dividend ETF that focuses on a particular strategy, such as dividend appreciation or high yield. 

Like dividend stocks, ETFs typically pay dividends quarterly or annually. ETF dividends may be received as income, or the investor may choose to have the dividends automatically buy more shares of the dividend ETF. 

Thematic Investing 

A thematic ETF investing strategy involves buying ETFs that focus on trending investment themes rather than specific types of investment security. For example, a typical thematic ETF might invest in stocks of companies that may benefit from potential growth in technological, environmental or demographic shifts over time. 

There are over 300 thematic ETFs on the market that seek to capture investment opportunities in companies or sectors created by long-term structural trends, such as energy, cryptocurrency, emerging markets, and technology. One of the largest thematic ETFs on the market is the ARK Innovation ETF (ARKK). 

Bottom Line 

ETFs are low-cost investment vehicles that offer a wide range of choices, enabling investors to implement almost any kind of investment strategy, from a classic buy-and-hold strategy to hedging and thematic investing. Before choosing a fund to implement an ETF investment strategy, investors should be sure the fund fits their investment objective and risk tolerance.