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3 ETFs for a Diversified, Low-Cost Portfolio

Fri, 25 Aug 2017

Morningstar analysts discuss three highly rated exchange-traded funds that could form the backbone of a portfolio.

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Video Transcript

Jeremy Glaser: Many investors are looking to simplify their portfolios. We asked Morningstar analysts to provide three low-cost ETFs that could form the backbone of a portfolio.

Adam McCullough: Vanguard Total Stock Market Index Fund, VTI, is an excellent option for investors looking for broadly diversified, market-cap-weighted exposure to the U.S. market. This fund only charges 4 basis points a year for nearly every U.S. stock. It owns 3,600 stocks, but its holdings skew toward the biggest names such as Apple, Amazon, and Microsoft because its holdings are market-cap-weighted. That said, this fund still holds about 7% of its portfolio in small-cap stocks and another 3% in micro-cap stocks. During the past decade through July 2017, this fund topped the U.S. large-cap blend category average by 1.7 percentage points each year with similar risk.

That being said, this is still an index fund and remains fully invested. So, it will feel the full brunt of a market downturn. In fact, during the financial crisis, this fund lost 55%, which is more than the average fund in the large-blend category lost over the same time period. That being said, owning the entire U.S. market for 4 basis points per year is a very attractive proposition, and this fund earns a Morningstar Analyst Rating of Gold.

Dan Sotiroff: Vanguard Total International Stock Market ETF is an excellent choice for investment outside of the U.S. It includes stocks from both developed and emerging markets, and its broad reach includes, large-, mid-, and small-cap stocks. Its market-cap-weighted approach effectively diversifies its holdings, and right now only about 8% of its holdings account for its top 10 holdings. Vanguard recently cut the expense ratio on this fund, and the ETF and Admiral shares classes both charge 11 basis points. These are among the lowest fees in the foreign large-blend category and should give this fund a durable edge over the long term.

Phillip Yoo: Vanguard Total Bond Market Fund is a good option for building a diversified portfolio, thanks to its low fees, low tracking error, and a conservative portfolio. The fund tracks the Bloomberg Barclays Aggregate Float Adjusted Index, which is market-cap-weighted, allowing the fund to keep its transaction costs low as it tilts toward the largest issues and bonds. Because it's cap-weighted, the debt issuance activities in the investment-grade space dictates the portfolio. As a result, the fund consists of about 45% in Treasury bonds, 20% in agency mortgage-backed securities, and the rest in investment-grade corporate bonds. The large allocation to government securities provides downside protection. For example, the fund returned about 5% during the '08 global financial crisis; meanwhile, the intermediate-term category peers lost about 20% on average.

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