How & Why to construct your own ETF

As ETFs have become so popular that most of the investors just fire & forget, in my humble opinion they are missing out in unforeseen situations like this. In these times I try to make my own custom ETF and leave out whatever I don’t feel comfortable holding. As an example, in the SP500 right now you are getting exposed to restaurants, event & hospitality businesses, convention centers etc. Conventional wisdom says that this is priced in but I firmly believe that there is cognitive dissonance regarding the pandemic and people are skewed to be optimistic. Even if there are good opportunities there, the fat tail risk is too great.

A rational investor separates his desires from his money or he will quickly part with his money.

Let’s see how to do this below.

Step 1. Pick an ETF (duh)
Step 2. Find a list of all the holdings
Step 3. Pick a representative number of companies from each sector
Step 4. Decide which sectors are left out and why
Step 4. Buy them in small quantities and try to be proportional. Don’t buy the same amount of $AAPL and also the same amount of a company that has a much smaller capitalization.

Note that it is important and part of the game that we are not being very precise here. Diversification theory says that after 12 stocks diversification is not doing much at all. I am going for more companies than that but you get the point. You can buy 3 out of 5 airlines or 5 out of 7 restaurant shops or 10 out of 15 semiconductor manufacturers. Also, the difference that you will make if you try to be ultra precise with the weighting of each stock will be minuscule.

Caution: This takes up a lot of your time. If you want to be extra precise then you can research briefly many of the companies and cherry pick and then from time to time re-balance (something that is done automatically in an ETF). But again, these are unprecedented times.

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Disclaimer: The information on this site is for informational purposes and isn’t financial advice. We cannot guarantee that you will have the same results as we have nor can we guarantee that the information shared here is appropriate for you. This is not financial advice and not given by professionals.

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