Diversification is one of the key pillars of investing. It's another case of not wanting to put all your eggs in one basket. To achieve true diversification, you should be invested in companies from different industries, sizes, and locations. Doing so by investing in individual companies can be time consuming and nerve wracking, but you don't have to go that route.
With these four exchange-traded funds (ETFs), you can have a well-rounded retirement portfolio with just a few investments.
The one staple
If there were one "must-have" investment everyone needs in a stock portfolio, it would be an S&P 500 index fund. The S&P 500 tracks the 500 largest public U.S. companies and is the most followed index in the stock market. In fact, its performance is often used interchangeably with the overall stock market's performance.
Since the S&P 500 only contains large-cap stocks (those with a market cap over $10 billion), it generally provides more stability than funds that contain small companies. You may not see the hypergrowth that you can with smaller-cap stocks, but you can take comfort in knowing it's well equipped to weather bad economic storms.
An S&P 500 fund like the Vanguard S&P 500 Index Fund ETF(VOO -0.13%) can be a great choice because of its low cost (0.03% expense ratio) and diversification. It's weighted by market cap, so the larger a company's market cap, the higher percentage of the fund it makes up. This may make it more top-heavy than other ETFs, but it still manages to cover all bases sector-wise.
Don't forget the little players
Small-cap stocks have a market cap between $250 million and $2 billion. Because of their relatively small size, smaller-cap stocks tend to have more room for growth than larger-cap stocks. With this growth potential, however, comes more proneness to volatility because these companies typically don't have as many financial resources at their disposal.
Small-cap stocks, by nature, are riskier than larger-cap stocks, but you can offset some of this risk by investing in a small-cap index fund like the Russell 2000. The Russell 2000 tracks the smallest 2,000 stocks in the Russell 3000 index, and it's largely considered the go-to benchmark for small-cap stocks -- similar to the S&P 500 for large-cap stocks.
A Russell 2000 index fund such as the Vanguard Russell 2000 ETF (VTWO -1.30%) is low cost (0.10% expense ratio) and has a mix of value and growth stocks. You don't want small-cap stocks to be the bulk of your portfolio, but you should want to be invested in some.
A good balance
With market caps between $2 billion and $10 billion, mid-cap stocks can often be the best of both worlds: large enough to have a good amount of financial resources, yet small enough to still have room for lots of growth. You may not get the huge upside you would with small-cap stocks, but you also don't get the risk. And you may not get the stability that comes with large-cap stocks, but there's generally more upside.
The Vanguard Mid-Cap ETF (VO -0.59%) is low cost (0.04% expense ratio) and contains 360 stocks covering all 11 major sectors. Its top 10 holdings only make up 7.23% of the fund, so it's well diversified and not too top heavy like some ETFs can be.
Look outside the U.S.
To have a truly diversified stock portfolio, you shouldn't only invest in American companies. By doing so, you're limiting yourself and missing out on some great companies across the globe. International markets are typically divided into two categories: developed and emerging.
Developed markets are seen as having advanced economies, established industries, and solid infrastructure. Emerging markets may not have the advanced economics or infrastructure of developed markets, but they're seen as progressing that way, giving them more upside.
Instead of spending time researching different regions and the companies within them, you can lean on an international ETF like the Vanguard Total International Stock ETF (VXUS -0.38%). This ETF contains 7,991 companies in the following regions:
- Europe: 38%
- Pacific: 26.9%
- North America: 7.8%
- Emerging Markets: 26.8%
- Middle East: 0.5%
With the Vanguard Total International Stock ETF, you get exposure to companies in developed and emerging markets, as well as some household names like Samsung and Toyota. A good rule of thumb is to have around 20% of your stock portfolio in international stocks. You'll likely be glad you did.
Stefon Walters has positions in Vanguard Mid-Cap ETF, Vanguard S&P 500 ETF, and Vanguard Total International Stock ETF. The Motley Fool has positions in and recommends Vanguard Mid-Cap ETF, Vanguard S&P 500 ETF, and Vanguard Total International Stock ETF. The Motley Fool has a disclosure policy.
