Exchange traded funds, aka ETFs, are a remarkably useful investment option. ETFs are a way to buy into a mutual fund without having to make the often hefty minimum purchases that funds tend to require -- you can buy as little as a single share of an ETF. And like mutual funds, ETFs are the perfect way to diversify your portfolio with a minimum of effort. However, with literally thousands of ETFs available for purchase, picking just the right one can be quite a challenge.
For a one-investment stock portfolio
Sometimes simplicity is the way to go, especially if you are a hands-off investor who prefers to spend his time on other pursuits. For a well diversified, general-purpose stock portfolio, you can't go wrong with the Vanguard S&P 500 ETF (VOO 0.99%), widely known to be Warren Buffet's favorite ETF. Boasting an incredibly low 0.04% expense ratio, this ETF will give you a way to track the market at the lowest possible price. Of course, stocks alone are not enough to produce a diversified portfolio, which leads us to...
Image source: Getty images.
General-purpose bonds
If you want just one bond ETF in your portfolio, you could do worse than to pick the Schwab U.S. Aggregate Bond ETF (SCHZ 0.15%). Another index ETF that enjoys a low, low expense ratio of 0.04%, this ETF tracks the Bloomberg Barclays U.S. Aggregate Bond Index, which puts most of its holdings in US government bonds, mortgage-backed securities, and corporate bonds. The wide range of bond types represented in this ETF gives its investors excellent diversification in the bond market.
Going global
US-based stocks are not the only option these days; there's a whole wide world of investments out there, and an international ETF can give you easy access. For a low cost, broad-based international ETF, consider the Vanguard FTSE All-World ex-US ETF (VEU 1.00%). This ETF tracks the FTSE All-World ex US Index, which (as its name implies) includes stocks from all over the world except the USA. Because of the way that the stocks in this index are weighted, the ETF emphasizes large-cap companies, which makes it a bit less volatile than some international funds. And its expense ratio of 0.11% keeps fees to a minimum.
The REIT way
REITs, or real estate investment trusts, are an excellent option for diversifying away from stocks and bonds. Buying shares in an equity REIT is essentially investing in real estate on a tiny scale, and since real estate tends to react differently from either stocks or bonds to various economic conditions, such an investment can reduce your portfolio's volatility significantly. Once again Vanguard leads the way in this category, with its Vanguard REIT ETF (VNQ -0.02%) which tracks the MSCI US REIT Index. The ETF tracks only equity REITs, not mortgage REITs, which makes it a much less volatile option than many of its competitors. It also emphasizes larger REITs, which gives it a bit more stability (and lower risk). Last but not least, the moderate 0.12% expense ratio gives the ETF's returns a nice boost.
Other options
The above ETFs will give you a solid, general-purpose portfolio, but you may want to specialize your portfolio somewhat to meet your own needs and preferences. For example, someone approaching retirement would want to emphasize income and low volatility in her portfolio, so she'd want to replace some or all of the above ETFs with others that specialize in those areas. And many brokers will allow you to buy and sell the broker's own ETFs commission free, so if you have an account at Schwab or Fidelity you can save a lot of money by sticking with that family of ETFs. When choosing an ETF, look for index ETFs if possible to minimize fees. And remember, diversification is the name of the game: don't limit yourself to just one type of investment (say, large-cap stocks) no matter what your focus is, but spread your money out over a wide range of investments. Diversification increases returns, reduces risk, and generally makes for a fat, happy portfolio.
Wendy Connick owns shares of Vanguard S&P 500 ETF,Vanguard FTSE All-World ex-US ETF, andVanguard REIT ETF. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
FAQs
Generally speaking, fewer than 10 ETFs are likely enough to diversify your portfolio, but this will vary depending on your financial goals, ranging from retirement savings to income generation.
What is the 4 fund investment strategy? ›
The Four Fund Combo is built on four index funds (or exchange-traded funds) that include the most basic U.S. equity asset classes: large-cap blend stocks (the S&P 500 SPX, +0.27%, in other words), large-cap value stocks, small-cap blend stocks, and small-cap value stocks.
How many ETFs are needed for a diversified portfolio? ›
Experts agree that for most personal investors, a portfolio comprising 5 to 10 ETFs is perfect in terms of diversification.
What is a well balanced ETF portfolio? ›
What Is a Balanced Fund? A balanced ETF—also known as an asset allocation ETF—is a fund of funds that owns two or more different types of assets. Most commonly they hold a selection of stock and bond funds, with fixed allocations to each asset class.
What is the 4% rule ETF? ›
Known as the 4% rule, Bengen argued that investors could safely set their annual withdrawal rate to 4% of their initial retirement pot and adjust it for inflation without running out of money over a 30-year time horizon.
How many S&P 500 ETFs should I own? ›
SPY, VOO and IVV are among the most popular S&P 500 ETFs. These three S&P 500 ETFs are quite similar, but may sometimes diverge in terms of costs or daily returns. Investors generally only need one S&P 500 ETF.
What are the 4 C's of investing? ›
Trade-offs must be weighed and evaluated, and the costs of any investment must be contextualized. To help with this conversation, I like to frame fund expenses in terms of what I call the Four C's of Investment Costs: Capacity, Craftsmanship, Complexity, and Contribution.
What is a lazy portfolio? ›
A Lazy Portfolio is a collection of investments that requires very little maintenance. It's the typical passive investing strategy, for long-term investors, with time horizons of more than 10 years. Choose your investment style (Classic or Alternative?), pick your Lazy Portfolios and implement them with ETFs.
Is VTI or VoO better? ›
VTI is a total U.S. market fund and holds more than 3,500 stocks. VTI is better diversified and benefits from small and mid-cap stocks that grow into large caps. VOO is less diversified, tracking the performance of the S&P 500 Index. VOO excludes small and mid-cap stocks.
How many Vanguard ETFs should I own? ›
Build a fully diversified portfolio with just 4 ETFs
This level of diversification can help reduce your overall investment risk while making it easier to manage your portfolio.
Holding an ETF for longer than a year may get you a more favorable capital gains tax rate when you sell your investment.
Is there a 60/40 balanced ETF? ›
The Stocks/Bonds 60/40 Portfolio is a High Risk portfolio and can be implemented with 2 ETFs. It's exposed for 60% on the Stock Market. In the last 30 Years, the Stocks/Bonds 60/40 Portfolio obtained a 8.28% compound annual return, with a 9.63% standard deviation.
What is a well diversified ETF? ›
Diversified Portfolios ETFs offer investors exposure to multiple asset classes through a single ticker. These funds vary in investment objectives and risk/return profiles, but typically invest in a mix of equities and fixed income securities.
How much ETF overlap is too much? ›
In essence, if two ETFs share more than 50% of their holdings, it is deemed high overlap, which diminishes diversification benefits. For instance, if you own two ETFs — one tracking the S&P 500 and another tracking the Nasdaq 100 — you may find substantial overlap due to shared companies.
How much of your money should be in ETFs? ›
You expose your portfolio to much higher risk with sector ETFs, so you should use them sparingly, but investing 5% to 10% of your total portfolio assets may be appropriate. If you want to be highly conservative, don't use these at all.
How often should I invest in an ETF? ›
The best time to buy ETFs is at regular intervals throughout your lifetime. ETFs are like savings accounts from back when savings accounts actually paid you interest. Think back to a time when you (or your parents!) used to invest in your future by putting money into a savings account.
What is the 3% limit on ETFs? ›
Under the Investment Company Act, private investment funds (e.g. hedge funds) are generally prohibited from acquiring more than 3% of an ETF's shares (the 3% Limit).
