ETFs As A Core To Portfolio Building

Studies show that the majority of active fund managers do not outperform the markets consistently, a fact that has more investors considering exchange traded funds (ETFs) and other index products instead.

One of the best ways to build a portfolio using ETFs is to begin with the core.

The core is the main part of the portfolio, and as the word implies, it should be solid. This part focuses on getting the rate of return necessary to reach your financial goals, while cutting risk as much as possible, reports Rebecca Knight for Financial Times.

The first area to consider is fixed income and the allocation to this category is determined upon risk tolerance and investment horizon. Bonds can take anywhere from 10%-80% of a portfolio.

As for equities, a single total market fund is a start, such as the SDPR S&P 500 (SPY) or Vanguard Total Market (VTI). Make sure to get exposure to large-, mid- and small-caps through these funds. At least half the equity holdings in the core of a portfolio should be from companies outside the United States. If you look at trends, there is a heck of a lot more growth overseas these days.

Once the core is established, then look to asset classes such as commodities, real estate and emerging markets. If you really want to diversify from an index standpoint, you’ve got to use ETFs, but of course it depends on how diversified you want to be and how much work you’re willing to put in.

ETFs are well established and they have lower fees than mutual funds, however, there are brokerage fees to consider. Also, ETFs can serve as tactical allocation tools for overweighting and underweighting sectors of the market.

SPY is down 32.4% year-to-date, while VTI is down 32.6% year-to-date.

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