If you want to build an easy ETF portfolio, you're in luck! There are tons of financial products that will allow you to build a simple and efficient portfolio. Today's information rich environment will also allow you to turn the task of building a portfolio into an arduous and time consuming endeavor.
Building a portfolio shouldn't be difficult, and in my experience the time and energy it takes to build a complex portfolio isn't even worth it. Most mutual fund managers lag the market in terms of performance, chances are you will too. So if you're like me and don't want to waste a bunch of time, feel free to follow along and build your portfolio the easy way.
First, Determine the Right Asset Allocation
According to Modern Portfolio Theory, one of the key elements to consider when building an efficient portfolio is the mix of asset classes. Asset class mix can be described as the percent of your portfolio dedicated to particular asset classes.
In this first step we need to determine how much capital we should allocate to stocks, bonds, commodities, options, futures, etc. To keep this portfolio simple we will first look at a portfolio comprised of only stocks and bonds. Then we will discuss other assets classes, such as gold and real estate, that we can add to our portfolio to increase diversification.
The quickest way to determine a "good enough" asset allocation for an individual is the "100 minus your age" rule of thumb. To use this rule of thumb to determine what percent of your capital should be invested in stocks, just subtract your age from 100. The resulting number will be the percentage of your portfolio that should be allocated to stocks. The remaining balance should be allocated into bonds.
Second, Use ETFs for Diversification
Now that you know what percent of your portfolio should be invested into stocks and bonds, its time to find the specific assets to place into your portfolio. As mentioned earlier, the abundance of financial products makes this an easy task. To achieve a "good enough" diversification you only really need to purchase the following Exchange Traded Funds.
Vanguard Total Stock Market (VTI) - Including this fund in your easy ETF portfolio will allow you to track the performance of the U.S. stock market. This ETF includes large, mid, small and micro-cap stocks.
Vanguard Total Bond Market (BND) - This fund will enable you to track the performance of the Barclays U.S. Aggregate Float Adjusted Index. It includes both government and corporate bond issues with a maturity of more than one year.
I told you this was the World's easiest portfolio! However, if choosing a stock allocation based on your age and only investing in two ETFs is too easy, you can choose to add a few more asset classes to increase your diversification. To add more complexity to your easy ETF portfolio, I would consider dedicating a small percentage of my portfolio to each of the following international, real estate and gold funds.
Vanguard Total International Stock (VXUS) - This ETF will add international stock exposure to your portfolio. This fund tracks the FTSE Global All Cap and excludes U.S. stocks.
Vanguard REIT (VNQ) - This ETF will allow you to diversify into real estate investments by tracking the performance of the MSCI U.S. Real Estate Investment Trust (REIT) Index. This index represents roughly 85% of the publicly traded REIT market.
SPDR Gold Shares (GLD) - Investing in a gold fund will introduce a commodity into your portfolio while providing a good hedge against inflation. The SPDR Gold Shares ETF seeks to track the price performance of gold bullion (net of management fees).
If you want to get a little more complex and tailor your portfolio's risk and reward profile, you can choose to allocate your stocks based on different sized companies (i.e. small, medium and large capitalization). The following funds can help you customize your easy ETF portfolio based on your individual risk and reward preferences.
Vanguard Large-Cap (VV) - Include this fund in your easy ETF portfolio if you want an additional allocation to large companies. This fund has a moderate risk and reward profile.
Vanguard Mid-Cap (VO) - Investing in this mid-cap ETF will increase your exposure to companies with a higher risk and higher reward profile than larger companies.
Vanguard Small-Cap (VB) - If you want to increase the potential to outperform the S&P 500 and the Dow Jones Industrial Average, increase your allocation to small-cap stocks. Keep in mind that small companies are historically more sensitive to macroeconomic performance.
Third, Maintain Your Easy ETF Portfolio
Once in a while you will need to measure how "out of balance" your portfolio has become; in most cases once a year fine. Your easy ETF portfolio will need to be adjusted for two reasons. First, your portfolio's positions will gain and lose value at different rates over time. This will throw your allocation percentages off. Second, as you near retirement you should be reducing your exposure to riskier assets, such as stocks and increasing your allocation to bonds.
To re-balance your portfolio, determine what percent your stock and bond allocations should be by using the "100 minus your age" rule. Once you have determined where your allocation percentages should be, calculate the size of your current allocations.
If your positions are larger then they should be you need to "trim the positions". In other words, you will need to sell enough shares to reduce your allocation to where it should be. The gains from trimmed positions should be used to increase allocations (buy more shares) of positions that are smaller than they need to be.