Whether building a new investment portfolio from scratch or doing a portfolio renovation, exchange-traded funds (ETFs) are a great place to start.
ETFs provide broad exposure to a particular asset class and often at a fraction of the cost of comparable mutual funds. Most are passively managed meaning they track an index as opposed to actively managed funds which set out to beat an index and typically have higher expenses.
For investors whose main goal is to participate in the growth that equity markets can provide, low-cost ETFs are the way to go. A decade ago, the decision of which ETFs to buy was relatively easy because the choices were limited.
Today, there are over 2,600 ETFs listed on U.S. exchanges and thousands more trading globally. From broad-based funds like S&P 500 trackers to specialized thematic funds such as alternative energy ETFs, there is seemingly an ETF for everything these days.
This can make it overwhelming for new and experienced investors alike when it comes to developing a portfolio strategy. Fortunately, sometimes the best strategy is to keep it simple. Here are three solid building blocks that together cover approximately 90% of the global investable equity opportunity set.
The iShares Core S&P Total U.S. Stock Market ETF (NYSEARCA: ITOT) is an extremely low-cost way to gain exposure to U.S. stocks. With an ultra-low expense ratio of 0.03%, the fund tracks the performance of the S&P Total Market Index which includes large-, mid-, small-, and even micro-cap stocks. It goes well beyond the popular S&P 500 index funds to give investors access to the entire U.S. stock market in a single fund. Better yet, it is less expensive than most large-cap funds.
The ‘ITOT’ fund is a collection of 3,675 U.S. stocks wrapped in one. It is market cap-weighted so the likes of Apple and Microsoft have large weightings. As such, technology is by far the biggest sector exposure followed by health care and consumer discretionary, the latter of which includes hefty weightings in Amazon and Tesla. But as far as market cap-weighted U.S. stock funds go, this is about as diversified and low-cost as it gets. Vanguard and Schwab have similar low-cost total market ETFs that are viable alternatives.
Over the last 10 years, ITOT has generated an annual return of 16.1%. This is slightly below that of the S&P 500 due to the recent dominance of mega-cap stocks. More importantly, the fund provides exposure to smaller U.S. companies that have outperformed their large cap counterparts over long stretches and generally have greater growth potential. This makes ITOT an ideal all-in-one building block for the long-term portfolio.
To insert international stock exposure into a portfolio investors should look no further than the SPDR Portfolio Developed World Ex-US ETF (NYSEARCA: SPDW). This investment encompasses a broad group of developed economy companies excluding those that are based in the United States. More than two dozen countries are represented with the most weight in Japan (21%), the U.K. (12%), and Canada (9%).
‘SPDW’ gives investors a basket of 2,419 stocks for a miniscule 0.04% expense ratio. Expense ratio refers to the amount of a fund’s assets that are used to cover management fees and other costs and is expressed on a per year basis. So, for a negligible amount that won’t even be noticed, the investor gets access to all corners of the developed world that aren’t the U.S.
Aside from the country diversification, adding an international flair to an equity allocation diversifies the sector exposure. That’s because funds like SPDW have their highest weightings in financials and industrials. This helps reduce the reliance on technology, which in the case of SPDW is a modest 12%. The ETF is also far less top-heavy than most U.S. market-weighted funds. Its largest holdings (Nestle, Samsung Electronics, and ASML) are each less than 2% of the fund.
Lately, many investors have shied away from international stock funds because of their near-term underperformance. However, looking back at decades of historical returns, international stocks have been known to take the leadership reins from U.S. stocks. And with a significant gap in the valuations between the two asset classes, having an international equity allocation is still a wise move for the long-term investor.
Now that we have the developed world covered, it’s time to sprinkle in the Vanguard FTSE Emerging Markets ETF (NYSEARCA: VWO). It provides exposure to developing or emerging, economies that aren’t directly represented in U.S. and international funds.
These economies have been slower to recover from the pandemic due to slower vaccination rollouts, but are expected to experience some of the highest growth rates the world sees over the next decade and beyond. A recent Bloomberg study reported that “the center of economic gravity is shifting from West to East, from advanced economies to emerging markets”. This means that investors will want to have exposure to countries like China, Taiwan, India, and Brazil, all of which are part of the ‘VWO’ ETF. So too are more than 20 other countries.
Like international equity, emerging market equity has underperformed U.S. stocks in recent years. A rough 2021 for Chinese stocks only widened the gap. On the bright side, however, this has created a glorious opportunity for long-term investors to gain emerging market exposure at a discount. And with an expense ratio of 0.10%, VWO is the least costly way to implement broad emerging market equity exposure—and round out an incredibly diverse, low-cost stock portfolio.
Should you invest $1,000 in SPDR Portfolio Developed World ex-US ETF right now?
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