10 ETFs to build a diversified portfolio

Diversification is the only free lunch in investing. Here's how to follow that maxim properly via ETFs.

  • By Tony Dong,
  • U.S. News & World Report
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For a sound long-term investment strategy, experts urge diversification. This is the art of selecting different investment categories to spread out risk. For example, investors might add bonds to hedge against market crashes, bank stocks to protect against rising interest rates and commodities to take advantage of high inflation. Investors can also diversify across other factors such as geography, market sector, growth vs. value, and small- vs. large-cap stocks. A portfolio of different assets with varying correlations is likely to have a better risk-return profile compared with a 100% stock portfolio. To put it simply, diversification creates efficiency, allowing you to either take on the same return for less risk, or more return for the same risk compared with a single asset. Using exchange-traded funds, or ETFs, is an easy, low-cost method of diversifying with just a few tickers. Here are 10 ETFs you can buy to construct a diversified portfolio.

iShares Core S&P Total U.S. Stock Market ETF

The core of any U.S. investor's portfolio should be a sizable allocation to the domestic stock market. For maximum diversification, consider skipping popular indexes like the S&P 500 (.SPX) and head straight for the total U.S. stock market. A good way to capture this is by buying ITOT (ITOT), which holds a total of 3,647 stocks covering nearly the entire investable U.S. market. Most of ITOT – 82% – comprises of large-cap stocks, while the remainder has an assortment of mid- and small-cap stocks. The ETF is weighted according to each stock's market capitalization and will cost you a very low expense ratio of 0.03%.

iShares Core MSCI Total International Stock Market ETF

Although the U.S. has been on a decade-long streak of outperformance thanks to mega-cap tech stocks, older investors may remember the period from 2002 to 2009, colloquially known as "the lost decade," during which international stocks beat the U.S. handily. A good way to mitigate that risk is by including an allocation to international stocks, which make up around 45% of the world's investable market. IXUS (IXUS) is a great pick here, as it comprises 4,275 holdings from both international developed markets (Europe, Canada and Asia-Pacific regions) and international emerging markets such as the Middle East, Africa and China. The ETF also has a relatively low expense ratio of 0.07%.

Vanguard Total World Stock ETF

Most investors looking for "complete" world stock market coverage usually opt for a blend of both ITOT and IXUS at a 55/45 ratio or something similar. For an even easier one-ticket approach, consider replacing both with just VT (VT) instead. For a low 0.07% expense ratio, investors can put the stock portion of their portfolio on autopilot. VT invests in 9,551 stocks from around the world, with about 64% in North America, 15.5% in Europe and a chunk in the Pacific region and emerging markets. With this approach, you lose out on some tax efficiency – holding IXUS in a taxable account allows you to claim a foreign tax credit – but you also forgo the need to manually rebalance your allocations.

iShares U.S. Treasury Bond ETF

Even the most risk-tolerant, young investors should consider a small allocation to bonds in their portfolio, and U.S. Treasurys are the lowest-risk bonds around. An allocation to Treasurys helps reduce portfolio volatility and drawdowns during a market crash, which can help investors resist the urge to panic sell. While investors can pick and choose between short-, intermediate- or long-term Treasurys, an easier way is to buy an aggregate U.S. Treasury ETF such as GOVT (GOVT). GOVT provides exposure to 190 U.S. Treasurys ranging from one to 30 years to maturity for a cheap 0.05% expense ratio. With an effective duration of 6.49 years, GOVT isn't as sensitive to rising rates as long-term bonds are, but it still offers investors diversification and a modest hedge against stock market losses.

Vanguard Total World Bond Market ETF

U.S. Treasurys might be seen as the "risk-free" asset thanks to the backing of Uncle Sam, but there's a much larger bond market out there worth investing in. Corporate bonds, mortgage-backed securities, and even the government bonds of other nations can often offer better diversification via higher yields and a different risk profile. To capture these fixed-income securities, investors can buy bond ETF BNDW (BNDW). BNDW provides exposure to the global investment-grade bond market, with the ETF split evenly between U.S. and international bonds. BNDW costs an expense ratio of 0.06% and currently yields 2.7%.

SPDR Gold MiniShares

A combination of high inflation and multiple pending interest rate hikes created significant headwinds for both stocks and bonds in 2022, with traditional 60/40 portfolios losing just as much as all-stock portfolios. The best bet here for investors is adding assets that have a low correlation to both stocks and bonds, such as gold. Gold is still perceived today as a reliable store of value and a safe haven to flock to during an economic crisis. To track it, investors can buy GLDM (GLDM). GLDM provides actual beneficial ownership in a trust of physical gold bullion, which makes it an accurate way of gaining exposure to gold prices. Year to date, GLDM is up over 8% compared to the 7.9% decline of the S&P 500 and the 9.9% decline of 7-10-year Treasury bonds. Holding GLDM will cost an expense ratio of 0.1%.

Vanguard Utilities ETF

Diversifying your portfolio's stock exposure is also a good bet. Many indexes these days tend to be tech-stock heavy, which skews their performance based on just a few mega-caps. A good play is to tilt toward the utilities sector. The utilities sector has historically been lower-correlated with the broader stock market and less volatile as well. A good way of gaining exposure is by buying VPU (VPU), which holds 64 stocks from the U.S. utilities sector. Year to date, VPU is up 5.5% compared with the 7.9% loss of the S&P 500. The ETF has a relatively cheap expense ratio of 0.1%, and it pays a decent yield of 2.7% thanks to the high dividends many utilities stocks pay.

Invesco Optimum Yield Diversified Commodity Strategy No K-1 ETF

Commodities ETFs like PDBC (PDBC) are generally recommended for advanced investors who understand their unique risk profile and high volatility. PDBC uses derivatives called futures contracts to gain exposure to the price of commodities such as zinc, copper, crude oil, natural gas, wheat, sugar, soybeans and so on. The ETF is highly volatile, but offers a strong diversification benefit due to its low correlation with both stocks and bonds and its strong performance during times of high inflation. Year to date, PDBC is up over 34% as the annual inflation rate soared to 8.5% in March 2022. The ETF has a somewhat high expense ratio of 0.62%, which is typical for a derivatives-based fund.

Vanguard Real Estate ETF

Investors wary of the high valuations present in the current stock market can turn to the real estate market for high rates of return. While rental properties can be very lucrative, an easier option is to buy the shares of real estate investment trusts, or REITs, that invest in income-generating properties. An even easier option is to buy an ETF, like VNQ (VNQ), that holds the shares of 164 REITs. REITs have a lower degree of correlation to stocks, giving them the chance to perform well even when stocks falter. Although down on the year, VNQ is still outperforming the S&P 500. VNQ charges an expense ratio of 0.12%.

SPDR S&P 600 Small Cap Value ETF

In recent years, total market stock ETFs like ITOT tend to be dominated by the performance of large-cap growth stocks due to their market-weighted fund construction criteria. However, according to the Fama/French five-factor investing model, small-cap and value stocks are considered more likely to produce better returns over longer periods of time. An investor seeking a more diversified portfolio can choose to "tilt" their allocation of small-cap value stocks higher by buying an ETF like SLYV (SLYV). SLYV holds 460 small-cap value stocks with low price-book value, price-earnings and price-sales ratios. The ETF charges an expense ratio of 0.15%.

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