Experts agree that, for most personal investors, a portfolio of 5 to 10 ETFs is perfect in terms of diversification. But the amount of ETFs is not what you should consider. Rather, you should consider the number of different sources of risk you run with those ETFs. How can you tell if a portfolio comprised exclusively of ETFs makes sense for you? For the most part, it all boils down to what your goals and preferences are.
As a general rule, ETFs offer excellent diversification with a low Continuing Expense Ratio (OER), since many are passive funds that follow a certain benchmark index. Because of this, they usually offer transparency: it's easy to see what stocks, bonds, or other investments the ETF holds each day. If these are the main features you are looking for in your investments, having nothing but ETFs can be a simple but flexible solution that is worth taking a closer look at. There are some pros and cons to consider.
A portfolio comprised exclusively of ETFs means giving up actively managed mutual funds, which have the potential to outperform indexed ETFs through a professional selection of stocks and bonds. You'll also leave behind the control that comes with a portfolio consisting only of individual securities that you've selected. Some people won't want to give up on these things, even though these approaches also have specific drawbacks (see table below). If you think that an all-ETF portfolio might be right for you, here are three ways to create one, ranging from the simplest to the tightest.
For example, if you are an investor looking for moderate risk and decide that you want 60% of your portfolio in stocks and 40% in bonds, you could consider buying a stock index ETF for all countries and then combining it with a bond ETF. Global stock market ETFs can follow an index such as Morgan Stanley Capital International's All Country World IndexSM (MSCI ACWI), which exposes the U.S. UU. Stocks, international developed market stocks and international emerging market stocks.
Another drawback of this portfolio is that it lacks any allocation to inflation-protected Treasury securities (TIPS), underinvestment grade bonds (also known as junk or high yield bonds) and international bonds not denominated in dollars, not to mention other asset classes, such as commodities and real estate. Additional asset classes can help further diversify your portfolio. Even so, if simplicity is what you are looking for, a two-ETF portfolio may be an alternative worth considering. The advantage of this portfolio can help provide balance.
It has enough ETFs to cover more asset classes and the ability to adjust the weighting of the portfolio in most areas, but it doesn't have enough funds to make it too difficult to track. The downside of this portfolio is that it offers neither maximum simplicity nor maximum customization capacity. At the other end of the spectrum, from an ultra-simple ETF portfolio, there is a tight portfolio with 20 or more ETFs. This type of portfolio may make sense for investors who like to allocate their accounts to exactly the parts of the market where they expect to perform best.
Real estate ETFs can be added to the portfolio and can even be divided in the U.S. . For example, instead of maintaining allocations to the 11 stock market sectors and to all possible individual countries, core resources are likely to be allocated to certain ETFs and then weight will be added to ETFs that represent only those sectors or countries that appear most attractive. The advantage of this portfolio is the ability to gain almost exactly the exposure you want for each narrow part of the market and, at the same time, enjoy the diversification offered by ETFs versus individual stocks and bonds.
The downsides are the complexity and costs of trading. With so many ETFs in your portfolio, it's important to be able to keep track of what you own at all times. You could easily lose sight of your total allocation to stocks if you own 13 different stock ETFs instead of one or even five. In addition, with so many ETFs in the portfolio and relatively more purchases and sales, the impact of supply and demand differentials could add up quickly.
The information provided here is for general information purposes only and should not be considered an individual recommendation or personalized investment advice. The investment strategies mentioned here may not be right for everyone. Every investor should review an investment strategy for their particular situation before making any investment decision. All expressions of opinion are subject to change without notice in reaction to changing market conditions.
The data contained in this document from external providers is obtained from what are considered to be reliable sources. However, its accuracy, integrity, or reliability cannot be guaranteed. The examples provided are for illustrative purposes only and are not intended to reflect the results you can expect to obtain. Diversification, asset allocation and rebalancing strategies do not guarantee profits or protect against losses in declining markets.
Rebalancing can cause investors to incur transaction costs, and rebalancing a non-retirement account can create taxable events that may affect their tax liability. Some specialized publicly traded funds may be subject to additional market risks. Investment returns will fluctuate and will be subject to market volatility, so an investor's shares, when traded or sold, may be worth more or less than their original cost. ETF shares are bought and sold at market prices, which may be higher or lower than the net asset value (NAV).
All ETFs are subject to fees and management fees. See the Charles Schwab Price Guide for additional information. Treasury securities protected against inflation (TIPS) are inflation-linked securities issued by the U.S. Government whose principal value is adjusted periodically according to the increase and decrease in the rate of inflation.
Therefore, the amount of the dividend payable is also affected by changes in the inflation rate, since it is based on the principal value of the bond. It can fluctuate up or down. Repayment at maturity is guaranteed by the U.S. The government and can be adjusted so that inflation becomes the highest among the original nominal amount at the time of issue or that nominal amount plus an adjustment for inflation.
TIPS generally have lower yields than conventional fixed-rate bonds, and their price is likely to fall during periods of deflation, which could result in losses. International investments entail additional risks, such as differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging markets can accentuate these risks. Historically, small-cap stocks have been more volatile than the stocks of larger, more established companies.
Sectoral investment may involve a greater degree of risk than an investment with broader diversification. Commodity-related products, including futures, carry a high level of risk and are not suitable for all investors. Commodity-related products can be extremely volatile and illiquid and can be significantly affected by underlying commodity prices, global events, import controls, global competition, government regulations and economic conditions, regardless of how long stocks are held. Investments in commodity-related products may subject the fund to significantly greater volatility than investments in traditional securities and involve substantial risks, including the risk of losing a significant portion of its principal value.
The risks of real estate investment trusts (REITs) are similar to those associated with direct ownership of real estate, such as changes in the value of real estate and property taxes, interest rates, the cash flow of underlying real estate assets, supply and demand and manageability, and the issuer's creditworthiness. Investing in REITs may pose additional risks, such as real estate risk, interest rate risk and liquidity risk. Indices are not managed, they do not incur commissions, costs or management costs and cannot be directly invested in them. Charles Schwab Investment Advisory, Inc.
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