It's easy to get overwhelmed assembling a "complete" portfolio that covers all the bases. If you want the broadest diversification possible, you're looking at including large-, mid-, and small-cap stocks, international stocks covering both developed and emerging markets, investment-grade bonds, junk bonds, and real estate. And you could probably dive further into the weeds if you wanted to include things, such as gold, oil, and other odds and ends.
If you want to research and identify the best possible choices in each of these categories, you're probably looking at a portfolio of around a dozen different ETFs. For my ETF Focus subscribers, we do just that - slicing and dicing things many different ways to target the lowest costs, the highest yields, and the best risk-adjusted returns.
But what if your primary goal is simplicity? What if you have no interest in poring over financial statements, fact sheets, and mountains of information to constantly keep an eye on a complex portfolio of investments? What if you want everything that a complex portfolio provides but also keep it as simple as possible so you can set it and forget it?
Well, I've got the portfolio for you!
It consists of just two ETFs - one covering stocks and one covering bonds. How you divide them up is up to you, but it should be based on your risk preferences and goals. If you want balanced risk or are nearing retirement, a 60/40 stock/bond mix might work. If you're younger and more risk tolerant, maybe 90/10. Either way, these two ETFs should give you near total coverage of the stock and bond markets, respectively. Will it be perfect? Probably not perfect, but this ETF pair will get you close enough.
The Stock ETF - Vanguard Total World Stock ETF (NYSEARCA:VT)
I really like this fund because not only does it give you everything - large-, mid-, and small-cap stocks across all markets around the world - it does it cheap. The fund's expense ratio of 0.10% means you're paying next to nothing to own this portfolio.
The fund's breakdown of 60% Americas, 20% Europe, and 20% Asia is ideal. Investors generally like to invest in what they know, so the 40% allocation to foreign markets might make some uncomfortable, but it's a very good choice for investing in a global marketplace. These markets also tend to behave differently at different times, so this geographic diversification can actually result in lower portfolio risk overall.
With five different sectors maintaining allocations of at least 11%, this portfolio is well diversified. The overseas economies tend to be more heavily dependent on the financial and energy sectors, so that's why you see higher allocations to those areas and underweights in tech and consumer discretionary relative to the United States.
If you're concerned about the international exposure, keep in mind that most of the top holdings in this fund and the S&P 500 (SPY) are the same, with names, such as Alibaba (BABA) and Tencent (OTCPK:TCEHY) also showing up in VT.
Alternatives: There's not a great deal of competition in the global stock ETF segment. The iShares MSCI World ETF (URTH) is an option, but it's more than twice as expensive as VT and is almost exclusively large caps. Instead of VT, you could go with the combination of the Vanguard Total Stock Market ETF (VTI) and the Vanguard Total International Stock ETF (VXUS), especially if wanted to change the allocation of VT. You could also get yourself a slight savings on costs.
The Bond ETF - Fidelity Total Bond ETF (NYSEARCA:FBND)
FBND does pretty much the same thing as VT, but in the fixed income space. It covers government, corporate, and mortgage bonds, both in the U.S. and overseas and combines both investment-grade and junk bonds. The fund's expense ratio of 0.36% is definitely on the higher end and may be improved upon (as I'll get into shortly).
Interestingly, FBND has a 9% allocation, which could help temper some risk and give the fund's managers some dry powder to put to work at some point. The percentage of the portfolio in cash has been trending upward over the past couple of years (about 3% two years ago to 9% today) and could actually benefit the fund if rates continue rising. The remaining 2/3-1/3 split between government/agency and corporate bonds is pretty standard for diversified bond ETFs.
While this is considered a global bond ETF, it has very little allocated overseas. International bonds have never been terribly popular due to their relatively poor risk/reward tradeoff, lower yields, and inconsistent dividends, so I see little need to try to increase your exposure there.
Alternatives: It's harder to find a bond ETF that includes both investment grade and junk bonds together. You can save on costs if you opt instead for the combination of the iShares Core U.S. Aggregate Bond ETF (AGG) and the iShares 0-5 Year High Yield Corporate Bond ETF (SHYG). That pair would cost you around 0.10% (depending on how much you invest in each, of course) compared to the 0.36% of FBND but also would eliminate any international fixed income exposure that FBND would provide. Still, this might actually be a case of where going with two funds makes more sense than going with one.
The Portfolio
If you're going with the standard 60/40 asset allocation, here's what your two-ETF portfolio looks like overall.
Again, it's incredibly diversified and covers just about every corner of the marketplace. Yield seekers might balk at the relatively minor 4% allocation to real estate in VT, but keep in mind that these allocations can always be tweaked if you wish to add a sector fund, such as the Vanguard Real Estate ETF (VNQ), to the mix.
Conclusion
VT and FBND represent the type of funds that investors should seek out if they're not particularly sophisticated or just want something cheap and simple that they can park their money in for a decade or more. Are they perfect? Of course not. There will always be small pockets that some investors will feel are underrepresented or that won't necessarily match up with certain people's preferences. But for the purpose of setting someone up for long-term success, they work great.
If you're a 401(k) investor, you may find VT as an investment option in your workplace plan, but FBND, probably not. In this scenario, the alternatives I mentioned make a lot of sense since VTI, VXUS, and AGG are popular options in 401(k)s.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
Model portfolio strategies like these are a big part of ETF Focus. It is dedicated to helping investors make smart investing decisions and develop broader investing strategies using, you guessed it, ETFs! If you're interested in joining our growing ETF community, now's the perfect time!
With your subscription, you'll receive:
- Our weekly "ETFs in Focus" feature where I present my top ETF ideas.
- ETF-based model portfolios for dividend income, target yields, and low fees.
- ETF power rankings covering hundreds of funds in two dozen categories.
- First access to ETF trade ideas every month.
Click here now to learn more!
