ETFs Build Cheap Portfolios

5/18/2009


With more than 740 exchange-traded funds (ETFs) now available, building a diversified ETF portfolio has never been easier.

We recommend mostly actively managed, traditional mutual funds. But investors who have embraced ETFs and prefer low-cost index funds may wish to consider the two all-ETF portfolios in the table below.

ALL-ETF PORTFOLIOS
— % of Portfolio —
ETF (Price; Ticker)
Conser-
vative
(%)
Growth
(%)
Exp.
Ratio
(%)
Yield
(%)
Category
iShares Barclays MBS
($106; MBB)
6
0
0.25
2.9
Ginnie Maes
iShares iBoxx $ HY Corp.
($77; HYG)
7
5
0.50
12.8
High-yield bonds
iShares MSCI EAFE
Value ($42; EFV)
8
9
0.40
0.2
Int'l large value
iShares S&P 500
($91; IVV)
7
7
0.09
2.8
Large-cap blend
iShares S&P Conserv.
($26; AOK)
0
7
0.31
2.8
Balanced bond bias
iShares S&P MidCap 400
Gro. ($61; IJK)
6
7
0.25
0.7
Midcap growth
iShares S&P MidCap 400
Val. ($52; IJJ)
5
9
0.25
3.0
Midcap value
iShares S&P Moderate
($25; AOM)
9
10
0.32
2.5
Balanced stock bias
iShares S&P SmallCap 600
($44; IJR)
6
8
0.20
1.7
Small-cap blend
SPDR DJ Small Cap Value
($44; DSV)
7
8
0.25
3.1
Small-cap value
SPDR S&P Dividend
($39; SDY)
8
10
0.35
5.4
Large-cap value
SPDR S&P Int'l Small Cap
($20; GWX)
5
7
0.59
2.1
Int'l small blend
Vanguard Emerging
Markets ($30; VWO)
0
5
0.27
0.0
Emerging market
Vanguard Growth
($42; VUG)
6
8
0.10
1.5
Large-cap growth
Vanguard Total Bond Mkt.
($77; BND)
20
0
0.10
4.2
Intermed. bonds

The all-ETF portfolios roughly correspond to the allocations of our recommended Growth and Conservative portfolios. Both portfolios consist of 13 ETFs with weightings that match our recommended mutual funds. While it is impossible to replicate the exact style and objective of most of our suggested mutual funds, the ETFs mimic their main attributes. The ETFs we picked tend to share some common characteristics:

All 13 have expense ratios below their category average. Brokerage commissions apply to each trade.

All of the ETFs are tied to notable indexes and have meaningful average daily trading volume, which improves share liquidity and typically leads to smaller bid-ask spreads.

All but two relatively new ETFs — iShares S&P Moderate Allocation ($25; AOM) and iShares S&P Conservative Allocation ($26; AOK) — have sizable asset bases, indicating healthy investor interest, good liquidity, and less risk that a fund will close.

The funds have solid relative year-to-date performance and, with the exception of the two new ETFs, good relative 12-month returns.

Our all-ETF portfolios should appeal to thrifty investors. The all-ETF Conservative Portfolio has an expense ratio of 0.26%, versus 0.29% for the all-ETF Growth Portfolio. Assuming a commission of $10 per trade, the total cost to purchase either portfolio is $130. Considering both annual expenses and brokerage fees (including a one-time rebalancing), the total first-year cost of owning the all-ETF Conservative Portfolio would be about $389, or 0.78% of a $50,000 account. The all-ETF Growth Portfolio would cost around $407, or about 0.81%.

The portfolios should also appeal to income investors. Based on estimated yields for the underlying ETFs, the all-ETF Conservative Portfolio yields about 3.5%, while the all-ETF Growth Portfolio yields about 2.8%. More importantly, both portfolios have held their own in 2009. Through May 12, the all-ETF Conservative Portfolio is up 2.4%, while the Growth Portfolio has gained 4.4%. So far this year, the S&P 500 Index has returned 1.7%, while the Barclays Capital U.S. Aggregate Bond Index has climbed 1.2%.

The table below provides a summary of portfolio characteristics. U.S. stocks anchor both portfolios, with a slight bias toward large-cap names. Value dominates growth in both portfolios. The all-ETF Conservative Portfolio is roughly 32% invested in bonds, versus 10% for the all-ETF Growth Portfolio.

PORTFOLIO STATISTICS
—– All-ETF Portfolios —–
Conser-
vative
Growth
Estimated Allocations 
U.S. Stocks
47
61
International Stocks
14
22
Bonds
32
10
Cash/Other
7
7
Stock Weightings 
Large-Cap
37
37
Midcap
36
35
Small-Cap
27
28
Style Summary 
Value
41
39
Blend
32
33
Growth
27
28
Estimated Yield
3.5
2.8
Expense Ratio
0.26
0.29
YTD Return
2.4
4.4

Conclusion
Many investors turn to ETFs to build diversified portfolios, as most offer an attractive combination of trading flexibility and low costs. While the funds offer an alternative to traditional mutual funds, they are not the complete answer. Expenses are an important piece of the puzzle, but an investor’s primary goal should be to find the very best funds. To that end, the table below lists our top mutual-fund picks, the building blocks for our Growth and Conservative portfolios. We expect our chosen funds, most of which are actively managed, to outpace index funds and ETFs. 

FORECASTS FUND RECOMMENDATIONS
Through May 12, our recommended Growth Portfolio gained 5.7% this year, versus 2.3% for its benchmark portfolio and a gain of 1.7% for the S&P 500 Index. The conservative Portfolio increased 5.0%, versus 2.1% for its benchmark.
— Year-to-Date —
—— % of Portfolio ——
Fund (Price; Ticker)
Return
(%)
Rank
Conser-
vative
(%)
Growth
(%)
Baron Asset ($38; BARAX)
6.4
D
6
7
Dreyfus Small Cap Stock Index
($13; DISSX)
(1.5)
E
6
8
Fidelity Export & Multinational
($16; FEXPX)
8.1
B
6
8
Fidelity Leveraged Co. Stock
($17; FLVCX)
18.1
A
0
0
Heartland Select Value
($19; HRSVX)
3.5
C
5
9
Heartland Value Plus
($19; HRVIX)
3.0
B
7
8
Northern Small Cap Value
($10; NOSGX)
(6.4)
E
0
0
T. Rowe Price Int’l Discovery
($27; PRIDX)
13.5
A
5
7
T. Rowe Price New Horizons
($19; PRNHX)
9.3
B
0
0
Vanguard 500 Index
($84; VFINX)
1.6
C
7
7
Vanguard Dividend Growth
($11; VDIGX)
1.0
D
8
10
Vanguard Emerging Mkts. Stock
Indx. ($19; VEIEX)
26.8
B
0
5
Vanguard GNMA ($11; VFIIX)
2.7
B
6
0
Vanguard Inter.-Term Tax Exempt
($13; VWITX)
5.7
C
0
0
Vanguard International Value
($25; VTRIX)
5.0
B
8
9
Vanguard Short-Term Invest.-Grade
($10; VFSTX)
5.3
A
0
0
Vanguard Total Bond Mkt. Index
($10; VBMFX)
1.4
E
20
0
Vanguard Wellesley Income
($18; VWINX)
(0.5)
E
0
7
Vanguard Wellington ($25; VWELX)
2.8
D
9
10
Wells Fargo Advantage
High Income ($6; STHYX)
14.4
E
7
5
* Rankings through May 12 from Morningstar, comparing performance among funds with same objectives. A = top 20%; B = next 20%; C= middle 20%; D = next 20%; E = bottom 20%. c Closed to new investors.

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