ETFs Build Cheap Portfolios
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.
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.
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.