How ETFs fit into your portfolio

You can set up systematic investment plans (SIPs) on exchange-traded funds (ETFs) to accumulate wealth to achieve life goals. You can also actively trade ETFs to capture short-term gains from their price movements. In this article, we discuss how to set up a simple process to do both.

The core-satellite framework refers to the process of simultaneously creating goal-based (core) portfolios and a trading (satellite) portfolio. The objective is to profit from short-term trends in the market without compromising on your life goals.

Now, suppose you invest in an ETF on the Nifty Index. You can set up an SIP matching the time horizon of a life goal. For instance, if one of your goals is for eight years, you can set up a monthly SIP for eight years. You can choose the same ETF for your satellite portfolio.

The difference is that you should time your entry and exit for your satellite portfolio. Because you are trading the same ETF with two different objectives, the cash flows must be easily identifiable to efficiently manage the investments. You must, therefore, have two different trading accounts —one account earmarked for the core and the other for the satellite.

You can have one account in your family member’s name and the other in your name.

This is important for operational efficiency. You will trade frequently in your satellite portfolio, buying when the Nifty Index declines and selling when the index hits your price target.

This trading account must be linked to a bank account that is only meant for your satellite portfolio. The other account from where you set up SIPs on the ETF must be linked to a master savings account from where you manage all the SIPs for your goal-based investments (core portfolio).

That way, whenever you rebalance (sell units to realise gains) your ETF investments, the proceeds are credited to your master savings account. This helps you to easily identify the sale proceeds and reinvest in bank deposits earmarked for that goal. ETFs are typically passive products. Such products are expected to mirror their benchmark index before costs.

So, all ETFs on the same benchmark will generate similar returns. This moderates regret that you could suffer from when you invest in active funds because the funds you did not choose could perform better than the ones you did.

For a chosen benchmark, whether broad-cap or large-cap index, it is best to pick an ETF with high liquidity.

(The author offers training programmes for individuals to manage their personal investments)