ETFs allow individual investors to buy securities that match the various stock and bond market indices at very low expense ratios. Not only do they have very low expense ratios compared to mutual funds but ETFs trade like stocks for less than $10 for a single trade. This general approach of creating portfolios using ETFs is also known as Lazy Portfolios as discussed in Market Watch. There's much food for thought at that link. There's nothing lazy about them however. They are buy and hold portfolios that only require re-balancing from time to time.
Active Portfolio Management Doesn't Work
There's a saying, "you can't beat the market" by picking stocks on your own. It's true. Even most hedge fund or mutual fund managers do not consistently beat the S&P 500 index. Then they charge big fees of 1 to 2% of your portfolio per annum for their under-performance! On the other hand, the management fees for most ETFs is only about 0.2% per annum---or about 10 times less.
So, if the professionals can't beat the market, then just buy the market! Now the small investor can "buy the market" easily now using ETFs. For instance, you can buy the entire S&P 500 index by buying the ETF "stock" with the symbol SPY. It trades at a price of 169 today. So, you can buy $100,000 of this security (index) with a single transaction costing less than $10.
Basic Portfolio Management
Most investors know that 60% stocks and 40% bonds is a classic portfolio mix that is widely recommended. If you're a young man of 28 years old, then you might want more like 70% stocks and 30% bonds. The beauty of this type of mix is that when stocks go down 'hard', bonds usually go up 'hard' to balance the portfolio. When stocks soar, bonds usually drop. Also, in normal times, bonds add 4 or 5% interest income on top of 3 or 4% annual bond price appreciation. Stocks typically yield 3% in addition to an average of about 6 or 7% price appreciation (per annum). However, we don't live in typical times----more about that below.
For the 60% stock portion of your portfolio, most investment professionals would recommend at least 50% Large Caps Stocks and 50% small Cap stocks. This equates to 30% Large Caps and 30% Small Caps for the overall portfolio. Many recommend a blend of world stocks to the mix as well. See my own portfolio compositions below.
For the 40% bond portion of your portfolio, a mix of US Treasury Notes and Bonds is recommended. Say 35% short term Treasury Bills, 30% intermediate term Treasury Notes and 25% long term Treasury Bonds. (15%, 12%, 10% respectively of total portfolio). Utility stocks, corporate bonds or preferred stocks can be used as bond proxies but they don't generally move opposite to stocks in times of stress---they go down too.
The following is a good list of ETFs to use they are designed to follow market indices for both stocks and bonds. This is a good list to start your own research. FYI, a good place to research ETFs is found here. The Lazy Portfolio articles are very good for recommended portfolio mixes. It's really not complicated.
Lazy portfolios typically give about 6 to 7% annual price appreciation plus about 2% dividends and interest. With the bond components, they don't drop as far as the S&P in a down year. In 2008, a 60/40 stock and bond blend was only down 16 to 17% but the S&P was down 36%.
SPY S&P 500 Large Cap Index, 2% yield
VB US Small Cap Index, 1.5% yield
VUE FTSE World Stock Ex US, 3% or more yield
EFA MSCI EAFE Index Fund (Europe, Australasia, Far East) Large Cap*
EEM MSCI Emerging Markets Index, 1.94% yield
VGK FTSE Developed European Stock Index, 3% yield*
ADRE Emerging Markets 50 ADR Large Cap Stock Index, 2.63% yield
FBT ARCA Biotech Index (Mid/Large Cap), 0% yield
AGG Aggregate Total Bond Market Index 2.85%
IEI Shorter term (3 to 7 Year) Treas Notes, 0.6% yield
IEF Intermediate term (7 to 10yr) Treas bond, 1.66% yield
BIV Vanguard Intermediate Municipal Bonds 3.2% plus cap gain dist
MUB Long Term Municipal Bonds 3%
BND Total US Bond Market, all maturities, 3.2%
MUNI Municipal bonds 2.5% yield, Mixed Maturities by PIMCO
TLT Long Treasury Bond, 20+ Years duration, 3% yield
* Indicates poor performance since 2008 due to European exposure--a contrarian play?
Every quarter, or after a big market move, it's important to "rebalance" your portfolio of ETFs. If the stock portion of your portfolio has gone up from a target of 60% of the total portfolio to say 68%, then you should sell some stocks to restore the 60% ratio. With those proceeds, you should put that money in the bond portion to stay close to your 60/40 or 70/30 stock/bond target mix. This is a good way to take some "money off the table" when one category has over-performed and put money toward to the under-performing category. In our current times, keep plenty of money in cash to take advantage of big moves down in either stocks AND/OR bonds. We may be near a time where both stocks and bonds go down simultaneously as interest rates normalize.
My IRA PortfolioFor your reference, this is my IRA portfolio mix. Since we live in government-manipulated markets, especially bond markets, it is advisable to have a good amount of cash on hand and tend toward short term bonds until bond yields rise toward about 3 or 3.5% on the 10 Year Treasury and 4 to 4.5% on the 30 year Treasury Bond. When the Federal Reserve stops buying bonds (and eventually raise the Fed Funds rates), then interest rates will have normalized. That may be many years from now is the problem.
Here's my IRA. Refer to the symbols above for descriptions:
CPXAX 9.0% (a preferred-stock mutual fund carried over from before--it acts like long term bonds)
My Taxable Account Portfolio
Also for your reference is my projected portfolio mix for my taxable account. My taxable portfolio is still in defensive mix of mutual funds. I'm waiting for a stock market pullback this fall to convert to the ETF portfolio below.
Since there are income taxes on this account, I've tried to blend in some Municipal bonds along with taxable Treasuries. Again, I'm keeping some cash and leaning toward short to intermediate bonds until interest rates normalize. Also, I've added some Emerging Market, Europe and Asian Stocks to this portfolio because these stocks have performed poorly over the past 5 years.
Stocks (50% total)
Bonds (35% total bonds)