3 ways to prime a portfolio with ETFs for 2017

Building a portfolio can be a daunting task, especially at an economic and political turning point like now. Here are three things that investors can consider doing to start the new year.

The swirl around the U.S. election pulled the markets sharply into its vortex. The surprise came in the intensity, scope and direction of the trading activity. Most notably, the weeks following the election saw the birth of the “Trump put,” in which economic optimism buoyed U.S. stocks to record highs, while taking down once-loved sectors like bonds and emerging markets.

As we’ve seen in previous periods of intense trading, exchange traded funds (ETFs) once again stepped in to provide investors with orderly, efficient portfolio repositioning. On November 9, the day following the election, ETF trading volume doubled, to 3.2 billion shares, according to Bloomberg; that week, U.S. stock ETFs absorbed flows of $27 billion, a record.

Chart Retail Flows

How to get buttoned-up in 2017

Given this past year’s tumult, what should investors look for in the months ahead? The recent market frenzies, while dramatic, have simply brought to the surface investment themes that have been percolating for some time—around global growth, interest rates, corporate earnings and ultimately how much return you should expect for your risk.

We can’t know exactly how and when these themes will play out, but there are steps you can consider to potentially position yourself for success. Here are three investment ideas and ways to consider when executing with ETFs:

1. Welcome back, inflation

The ongoing trend toward reflation—rising wages, higher core inflation, a strengthening dollar and stabilizing oil prices—may be accelerated by Trump’s win.

Investment Idea: Think about hedging across asset classes, including Treasury Inflation Protected Securities (TIPS), real estate and cyclical stock sectors that may benefit from potential economic growth and a steeper yield curve. Consider iShares TIPS Bond ETF (TIP), iShares Core U.S. REIT ETF (USRT), and iShares Mortgage Real Estate Capped ETF (REM).

2. Get granular with your emerging markets

Despite the post-election volatility in emerging markets (EMs), a strategic weighting to the overall asset class may make sense both as a diversifier and a potential return enhancer. However, there’s increasing divergence among emerging economies, which can get lost in the China-heavy broad EM index.

Investment Idea: Single country ETFs can complement a broader allocation by helping to pinpoint specific opportunities; we currently favor EM Asia, for example. You might also look at Saudi Arabia, which is implementing market reforms and targeting inclusion in the MSCI EM Index in 2017. Consider iShares MSCI India ETF (INDA), iShares MSCI Indonesia ETF (EIDO) and iShares MSCI Saudi Arabia Capped ETF (KSA).

3. Reduce “bad” taxes as close to zero as possible

We believe stock markets are in for an extended period of subpar returns, even with the recent rally. That means minimizing costs is more important than ever. Make this the year to be tax-smart by aiming to reduce capital gain distributions that are triggered when fund managers realize a profit on the sale of a security. Regardless of your fund’s return, you can owe taxes on it.

Investment Idea: ETFs in general are structurally tax-efficient and have lower turnover than actively managed mutual funds. (iShares is especially tax-conscious: just 3% of our ETFs distributed cap gains over the past five years, according to Morningstar data as of 11/12/2015. Past distributions are not indicative of future distributions.) Accentuate “good” taxes instead, namely those with a cash benefit to you. Think potentially higher-yielding ETFs such as dividend growth and preferred stocks. Consider iShares U.S. Preferred Stock ETF (PFF) and iShares Core Dividend Growth ETF (DGRO).

If one thing is certain right now, it’s that we’re truly at an economic and political turning point. In the face of such major change, building a portfolio may feel daunting—like dressing in the dark and hoping you come out reasonably put together. Fortunately, there are things investors can do to shed some light on the markets and start the year buttoned-up.

Martin Small is the Head of U.S. iShares and a regular contributor to The Blog.

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The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective. The information presented does not take into consideration commissions, tax implications, or other transactions costs, which may significantly affect the economic consequences of a given strategy or investment decision.

This post contains general information only and does not take into account an individual’s financial circumstances. This information should not be relied upon as a primary basis for an investment decision. Rather, an assessment should be made as to whether the information is appropriate in individual circumstances and consideration should be given to talking to a financial advisor before making an investment decision.

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TIPS can provide investors a hedge against inflation, as the inflation adjustment feature helps preserve the purchasing power of the investment. Because of this inflation adjustment feature, inflation protected bonds typically have lower yields than conventional fixed rate bonds and will likely decline in price during periods of deflation, which could result in losses. Government backing applies only to government issued securities, and does not apply to the funds.

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