Diversify your portfolio with these types of ETFs

Similar to stocks, bonds and mutual funds, exchange-traded funds (ETFs) are securities you can add to your investment portfolio. They're another way to potentially grow wealth while working toward your financial goals.

ETFs aren't a new security: 2023 marks the 30th year since the first ETF was listed in the U.S. Many types of ETFs have since sprouted up, and they can help you diversify your portfolio. Reviewing the most popular varieties of ETFs can help you and your financial advisor match your choices to your risk tolerance, time horizon and broader financial strategy.

Like mutual funds, ETFs are investments that let you purchase an interest in a basket of stocks, bonds or other assets. But unlike a mutual fund—which isn't exchange-traded and only trades once at the end of the day—you can buy and sell shares in ETFs at fluctuating market prices on exchanges throughout the trading day. That's how they resemble conventional stocks.

Most ETFs track the performance of a market index. For example, if you want to gain broad exposure to large-cap U.S. equities, you can buy an ETF that invests in most or all of the securities in the S&P 500 Index.

Managing risk while pursuing growth or income are common goals of investing. With such a variety of ETFs to consider, they're a popular way to practice asset allocation. This strategy involves diversifying your portfolio with assets that react differently to market conditions so that gains in some holdings can offset losses in others.

The most popular ETF asset classes include:

Equity ETFs typically track an index of stocks, which can be great vehicles for building long-term wealth. Some indexes are broad, like ones that track the entire U.S. stock market.

Other equity ETFs let you target more pointedly within the stock portion of your portfolio. For instance, you can buy equity ETFs that invest in stocks with a specific market capitalization, like those within certain sectors or that pay dividends. You can also purchase a collection of growth or value stocks.

Fixed income ETFs typically track an index of bonds and, true to their name, provide income. Some bond ETFs mirror the total bond market. Others provide exposure to different slivers—and to different levels of risk inherent in bonds related to interest rates, inflation and defaults.

Fixed income ETFs make it easy to purchase hundreds of bonds that share a characteristic. You can buy a basket of short-term bonds, intermediate-term bonds or long-term bonds. Some ETFs track an index of U.S. Treasury bonds or municipal bonds. If you're looking for investment-grade or high-yield bonds, you can buy ETFs with an assortment of each.

Commodities like precious metals, oil, natural gas, cattle and wheat have historically shown low or negative correlations with assets like stocks and bonds. They can also be an inflation hedge.

Yet, accessing raw materials to help balance risk over time can be challenging to manage. Commodity ETFs, which may hold physical commodities or invest in commodity futures contracts, make it easier to add commodities to your holdings.

Investing in currency markets can add diversification to your portfolio but can prove tricky to handle on the individual level.

Currency ETFs help you take advantage of exchange rate fluctuations. They typically track a single currency or a basket of currencies. Still, with so many macroeconomic factors at play, this can be a particularly complicated asset class to juggle.

Historically, real estate has a relatively modest correlation to stock market performance, making it a nice addition to your portfolio. Real estate can also hedge against inflation and generate income.

Real estate ETFs invest in the real estate market, with most primarily holding real estate investment trusts (REITS). These entities can operate properties like office buildings, shopping centers and hotels. By law, REITs have to distribute at least 90% of their taxable earnings to shareholders in the form of dividends, and you pay taxes on the income.

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How ETF fees work

Expense ratios of ETFs can vary. Here's what you need to know about expense ratios and how they can affect your investments.

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There were 5,697 ETFs in the U.S. and Europe at the end of 2022, according to the management consulting firm Oliver Wyman, and total ETF assets under management reached $6.7 trillion. The company notes, "The growth in ETFs has been the single most disruptive trend within the asset management industry over the last 20 years."

Many investors generally appreciate an ETF's ease of access, lower cost and tax efficiency. There's also been a lot of innovation in the ETF space. While most ETFs passively track a market index and closely mirror its return, more and more investors are seeking actively managed ETFs. These investors want to purchase ETFs that attempt to outperform indexes—and they're willing to pay higher fees to have a professional choose securities for the fund.

Of course, like other investments, ETFs can still decline in value and you can face losses, so you'll want to approach an ETF with an investment strategy in mind.

As you build a well-rounded investment portfolio, you can likely find ETFs that expose you to nearly any assets you desire. When deciding which to move forward with, stick with the asset classes that can help you achieve your investment objectives while aligning with your risk tolerance and time in the market.

Your financial advisor can help ensure you have a strong ETF investment strategy in mind, so that any portfolio selections you make—and any potential tax consequences or transaction fees that pop up—fit within your big-picture financial plan.