Can You Create a Diverse Portfolio with ETFs?

by Miranda Marquit · 6 comments

One of the most popular investments right now is the ETF. An exchange-traded fund is kind of like a hybrid between a mutual fund and a stock. You get the diversity of a fund, as well as easy trading — since, unlike mutual funds, ETFs are traded on an exchange like a stock.

You pay a transaction cost, such as the $4.95 you would normally pay to trade a stock, but you also have to pay the annual expense ratio. Even so, ETFs are often considered a good deal since the expense ratio is usually quite low (sometimes as low as 0.07%). And, if you choose the right broker, you can find an array of commission-free ETFs.

ETFs are often considered a good investment choice for many, but there are those who are wary of these relatively new investment products. I often receive the question, “Can I create a diverse portfolio with ETFs?”

The answer (and good news) is yes, you can. Here’s how.

Focus on Asset Class

In many cases, building a diversified portfolio with ETFs is about focusing on asset class. There are many ETFs built according to asset class. There are stock ETFs, bond ETFs, real estate ETFs, commodity ETFs, and currency ETFs. You can even find ETFs that are built around the idea of cash and cash-like products.

To get a very basic portfolio, you can choose ETFs according to your desired asset allocation. If you’re going with the very basic rule of “120 minus your age,” and you’re 30 years old, you’ll want 90% of your portfolio in stocks and 10% in bonds. Find stock ETFs to fulfill that 90%, and then buy bond ETFs to fill in the rest.

You can also mix things up a bit depending on how you want to include other asset classes. Perhaps you want 80% stocks, 10% bonds, and 10% real estate. Or, if you’re interested in holding gold, you might decide on 70% stocks, 10% bonds, 10% real estate, and 10% gold ETFs. (Make sure you understand the tax implications associated with gold ETFs.)

Figure out your desired asset allocation and buy index ETFs that match. That way, you end up with a diverse portfolio — and you can prevent too many eggs from ending up in one basket.

Consider Sector and Geography

It’s possible to further diversify your ETF portfolio by sector and geography. Your portfolio makeup should be mainly based on asset class, but can be changed as you go along.

Divide the stock portion of your portfolio using ETFs from different countries (or an all-world ETF) and choosing different sectors and cap sizes. There are index ETFs concerned mainly with Treasuries, as well as those that focus on foreign bonds and corporate bonds. With a little planning, you can take your main asset allocation and break it down a little.

And you can do it all with ETFs, which makes it easy to change things up if you need to.

What do you think? Do you invest with ETFs?

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{ read the comments below or add one }

  • Krystian Kowalczyk says:

    Well, I’m using ETF-s in my portfolio. Unfortunately in country where I live there are only 3 ETF’s available – for German DAX, US S&P500 and Polish WIG20 😉 So, as you see there are not many options here. I wish I could invest in REITS and commodities with ETF’s, but for now only mutual funds are available in that matter. So, I do invest mainly in mutual funds + US S&P500 ETF and do yearly portfolio rebalancing. The results are quite promising.

  • Peter N says:

    I too think that ETF are great when the investment is outside of a 401K or IRA. What I don’t like about mutual funds is that I must pay capital gains on other peoples trading. Mutual funds are OK in a tax free environment. ETFs are better in a taxable environment. The trick is to pick the right ETFs.

  • fredjohnson says:

    I only use 3 ETF’s/funds for my investing. Vanguard Total Stk Mkt, Vanguard Tot Intl Stk Mkt, and Vanguard Tot Bond Mkt. I have several million dollars in these 3 funds. And…….I’m talking “investing” here, NOT “trading”. My holding periods are several years to several decades. “Trading” is simply gambling and a fool’s errand.

  • Fez says:

    Hi Miranda.
    Thanks for great and educational post!
    Choosing different countries is for sure important sign of healthy portfolio.
    I always try to research market before investing in it.
    CIA Factbook is best place to find information about current affairs and issues in countries.
    Investing maps are good also – you can find many out there put together by major consulting and investment companies.

  • Conor Foley says:

    I’ve been trading ETF’s for the past 4 years and I wouldn’t go back to trading anything else. They are a brilliant investment vehicle. The trading costs are tiny and the liquidity is fantastic. You can create a portfolio to match any risk tolerance level. I am amazed they are not more popular. My guess is the name puts a lot of people off, because they sound too technical. I suspect the banks/brokers don’t push them that much either because the commissions are so low. My guess is that they will be far more popular in about 5 years.

  • paulkim says:

    I would like to share that with just three ETFs an investor can make a diversified portfolio.

    Investors can hold cheap index-based ETFs such as the Vanguard Total Stock Market Index ETF (NYSEArca: VTI), which has a 0.05% expense ratio; Vanguard Total International Stock ETF (NYSEArca: VXUS), which has a 0.16% expense ratio; and Vanguard Total Bond Market ETF (NYSEArca: BND), which has a 0.10% expense ratio.

    Overall, these three ETFs provide exposure to over 15,000 stock and bond components.

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