The Perfect Portfolio With Just 4 ETFs

By Gregory S. Davis | September 10, 2008 AAA

The U.S. market as tracked by the S&P 500 is down in the neighborhood of 14% so far this year. Investors concerned about inflation and the devaluation of the U.S. dollar, but still comforted by their investments in U.S. stocks can find relief with a compliment of four exchange-traded funds. (To begin with the basics, read A Guide To Portfolio Construction and Pump Up Your Portfolio With ETFs.)

Start With a Foundation
The SPDR S&P 500 Index (AMEX:SPY) offers investors exposure to both U.S. and international markets since approximately 45% of revenues from companies on the index are derived overseas. For example SPY's top holding Exxon Mobil (NYSE:XOM) reported that 69.18% of its revenues for the first half of the year were generated outside of the U.S. With the SPY acting as the portfolio foundation the next move is to add a non-correlated asset class. (To learn more about international diversification check out Going International.)

Add the Raw Materials

The PowerShares DB Commodity Index Tracking Fund (AMEX:DBC) grants investors access to a basket of commodities including crude oil, corn, wheat, aluminum and the flight to quality favorite gold. Commodities are thought of as a safe haven against inflation and as an asset class that moves in the opposite direction of the broad S&P 500 index. DBC has fallen back from recent highs in July, but it has still returned about 8.7% since the beginning of the year. A fixed income play is the next stop for our balanced portfolio.

Mix in Fixed Income

The iShares Lehman TIPS Bond (AMEX:TIP) is another inflation protection vehicle with the added benefits of low volatility and a healthy 5.91% yield. TIP can represent the fixed income foundation to give investors stability and a fund designed to rise along with the Consumer Price Index thereby easing the sting of a falling U.S. dollar. The TIP ETF has returned about 3.6% so far this year.

A Dash of International Flavor
The Claymore ETF:BNY BRIC (AMEX:EEB) offers investors exposure to fast growing markets outside of the U.S. including Brazil, Russia, India and China. The EEB fund has the greatest potential for growth in the balanced portfolio and will also carry the most amount of risk. An investor can reflect on EEB's return of about -32.7% since the beginning of the year as a barometer for the deep downturns investing in overseas markets can deliver.

Taste Test
Based on an investor's risk tolerance the portfolio can be balanced to meet his or her individual needs. Investors with a short time horizon should play it safe and heavily weight their portfolio with fixed income. Investors with more time to spare have the opportunity to absorb the pullbacks of volatile overseas investments.

To dig deeper into the subject of managing risk, read Measuring and Managing Investment Risk.

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