As exchange-traded funds (ETFs) have grown more popular among investors of all types, they have also become increasingly confusing and complicated. Particularly for those investors looking to invest in ETFs for the first time, it can be difficult to determine the best way to do so. Currently, there are close to 2,000 ETFs available to investors, covering a total of roughly $3 trillion in assets. While a consensus is building among analysts that low-cost, diversified passive ETFs are typically a strong investment approach, there are nonetheless several hundred different ETFs from which to choose. In this article, we explore some of the important considerations to keep in mind when building a basic ETF portfolio, according to a report by Forbes.
Stocks and Bonds
A straightforward portfolio is likely to include some combination of global stocks and U.S. Treasury bonds. Two broadly accessible ETFs that focus on large baskets of stocks are the Vanguard Total Stock Market ETF (VTI) and the Vanguard FTSE All-World ex-U.S. ETF (VEU). Between these two ETFs, investors have access to roughly 5,000 different stocks from all parts of the globe. VEU maintains exposure of 1% or more in 19 different countries, running the gamut from developed to emerging markets. VEU maintains an expense ratio of 0.11%, while VTI is even more affordable (with an expense ratio of just 0.04%).
If these two popular ETFs by Vanguard are not to your liking, there are other ways of gaining broad exposure to a large collection of global stocks. Many analysts feel that this is a good baseline approach for an ETF portfolio. (See also: Building an All-ETF Portfolio.)
In contrast with stocks, which have the tendency to move up and down considerably over time, bonds are much more stable, particularly during times of recession. For those investors who may get skittish when their stock assets drop considerably during a bear market, balancing out that portion of a portfolio with bond-focused ETFs can be a good remedy.
When you've decided on maintaining bond ETFs in your portfolio, you'll next need to determine the types of bond ETFs you'll hold. Government bonds are a great choice, as they tend to hold up very well when stocks are doing poorly. In contrast, corporate bonds tend to move more with the market, considering that they are issued by those companies that are represented by stocks. Forbes suggests that 10-year bonds have a good track record during recessions; for this reason, the Vanguard Intermediate-Term Treasury ETF (VFITX) is a strong choice to counter-balance against a stock portfolio. However, this ETF is not particularly diversified, so you may also consider the Vanguard Total Bond Market ETF (BND) to explore outside the U.S. as well. (For more, see: Bond ETFs: A Viable Alternative.)
ETFs are often seen as safer than many other modes of investing. Nonetheless, it's important to consider the level of risk when investing in ETFs. If you may need money soon, it might be safer to invest in the Short-Term Treasury ETF (VGSH) than in a stock-focused ETF. While the yield is somewhat lower than some of the above ETFs, it has a history of steady growth.
On the other hand, ETFs focused on emerging markets like China have seen tremendous growth in recent months, but they also carry a higher level of risk. While some of the stock names in places like China or India are included in international stock ETFs like those mentioned previously, there are also ETFs that narrow their focus on these markets. While these ETFs can appear cheap, you'll want to be careful about your risk in these cases. It might be best to control your exposure to ETFs focused on single countries.
When building your ETF portfolio, consider the money you'll need in the next five or ten years, how you'll split your investments between stocks and bonds, and then how you'd like to divide your exposure further within those categories. (For additional reading, check out: The Biggest ETF Risks.)