These ETFs offer diversification opportunities and low fees.
The recent bear market should serve as a somber warning for those with highly concentrated investment portfolios. Through the end of September, the benchmark S&P 500 is down about 25% year to date — but some pockets of the market have been hit even harder. Investors who piled into areas like high-growth tech, consumer cyclical stocks, special-purpose acquisition companies and meme stocks during the low-interest-rate bull market of 2020 to 2021 are likely nursing painful unrealized losses. Even bond investors suffered, with long-term Treasurys losing significant value thanks to aggressive interest rate hikes. During times like these, diversification is critical. This means constructing a well-allocated portfolio of stocks, bonds, alternatives and cash, each weighted to maximize return while reducing volatility. A great way to attain diversification is via exchange-traded funds, or ETFs. Here are 10 ETFs investors can buy in 2022 to build a portfolio.
Vanguard Total Stock Market ETF (ticker: VTI)
For American investors, the core of a properly diversified investment portfolio often begins with a healthy allocation to domestic stocks. Some investors, like Warren Buffett, prefer the brand name of the S&P 500, but for maximum diversification, consider the CRSP U.S. Total Market Index. This index holds about 4,000 large-, mid- and small-cap domestic stocks from all 11 market sectors, weighted by their market capitalizations. A great option here is VTI, which costs a minimal expense ratio of just 0.03%. On a $10,000 investment in VTI, investors can expect to pay $3 in annual fees.
Vanguard FTSE Developed Markets ETF (VEA)
U.S. stocks currently account for about 60% of the world’s total stock market, as measured by capitalization. For maximum diversification, holding some international stocks is prudent. This can hedge against the possibility of the U.S. stock market underperforming for a prolonged period, as it did between 2000 and 2008. A good choice here is VEA, which tracks the FTSE Developed All Cap ex US Index. VEA holds over 4,000 stocks from Japanese, British, Canadian, French, Swiss, Australian, German, Korean and Swedish companies, as well as other developed markets. The ETF is a great alternative to converting currency and purchasing individual foreign stocks or using American depositary receipts. VEA costs an expense ratio of 0.05%.
Vanguard FTSE Emerging Markets ETF (VWO)
International markets don’t just end with European or Pacific equities. The economies of developing nations, known as emerging markets, make for great diversification. Case in point, emerging market equities strongly outperformed U.S. equities from 2000 to 2003 when U.S. stocks suffered three straight years of losses following the dot-com bubble. A low-cost ETF to hold here is VWO, which tracks the FTSE Emerging Markets All Cap China A Inclusion Index. This ETF holds over 5,000 stocks from Chinese, Indian, Taiwanese, Brazilian, South African and Mexican emerging markets, among others. Valuations in emerging markets still trend low relative to domestic U.S. equities, and this may result in stronger returns in the future. VWO costs an expense ratio of 0.08%.
iShares Core U.S. Aggregate Bond ETF (AGG)
Bonds may have suffered their worst losses in over 40 years, but 2022 has been a rare case overall. With the exception of 1931, the late 1970s and this year, a diversified 60/40 portfolio of stocks and bonds has been a great blend of risk and return. For most investors, an allocation to investment-grade bonds matched to their risk tolerance and time horizon is prudent. A great one-size-fits-all choice here is AGG, which tracks the Bloomberg US Aggregate Bond Index. AGG holds both U.S. Treasurys and investment-grade corporate bonds. Seventy-three percent of the ETF is in AAA-rated bonds, so its holdings have extremely low default risk. With a duration of 6.39 years, AGG could be expected to lose 6.39% if interest rates rose by 1%, and vice versa if rates fell. The ETF costs an expense ratio of 0.03%.
iShares U.S. Treasury Bond ETF (GOVT)
Aggregate bond ETFs like AGG still contain an allocation to corporate bonds. While these bonds have higher yields, they also have greater credit risk. This causes them to have a higher correlation with equities, and thus they have a higher chance of losing value during a market crash. For maximum safety, investors can stick to U.S. Treasury bonds, which have lower yields but are “risk-free” when it comes to defaults. Treasurys have soared in value during numerous market crashes, including the 2008 and 2020 sell-offs. A great ETF to use here is GOVT, which holds a portfolio of U.S. Treasury bonds with laddered maturities averaging out to a duration of 6.49 years. GOVT costs an expense ratio of 0.05%.
SPDR Bloomberg 1-3 Month T-Bill ETF (BIL)
Older investors with a lower risk tolerance might find it helpful to keep a small chunk of their portfolio in cash. Cash is the ultimate safe asset. It might lose value to inflation but will preserve your capital during a crash. An alternative to high-interest savings accounts or a certificate of deposit that can be implemented in any brokerage account is BIL. This ETF tracks the Bloomberg 1-3 Month U.S. Treasury Bill Index, which holds ultra-short-duration U.S. Treasurys at the end of their maturity. BIL has a duration of 0.16 years, meaning it is expected to lose around 0.16% if interest rates rise by 1%. The ETF costs an expense ratio of 0.13%.
Pimco 1-5 Year U.S. TIPS Index Exchange-Traded Fund (STPZ)
High unexpected inflation is one of the biggest risks to diversified investment portfolios, given its negative impact on stocks, bonds and cash. Under these circumstances, investors can turn to Treasury inflation-protected securities, or TIPS, for protection. As a type of government bond, the price of a TIPS bond is indexed to inflation. If inflation surges suddenly, TIPS will be worth more and pay higher coupon interest. Investors can therefore substitute TIPS for some of their fixed-income allocation to hedge against inflation. A good pick here is STPZ, which holds TIPS averaging out to a 2.93-year duration, giving it decent resistance to rising interest rates. The ETF costs an expense ratio of 0.2%.
SPDR Gold MiniShares (GLDM)
After stocks, bonds and cash come alternative investments. These include commodities, with a precious metal like gold being one of the most affordable and easily accessible investments. Beyond its utility in electronics manufacturing, use as a reserve by countries and inflation-hedging abilities, gold also offers a substantial diversification benefit for investment portfolios. This manifests in its low correlation to both stocks and bonds, which potentially allows it to pick up the slack when both fall in tandem. A low-cost alternative to buying physical gold is via an ETF like GLDM, which tracks bullion held in secure, audited vaults. GLDM costs an expense ratio of 0.1%.
Invesco DB Commodity Index Tracking Fund (DBC)
Commodities don’t just end at gold. Crude oil, natural gas, soybeans, wheat, corn and other important commodities can be great portfolio diversifiers thanks to their low correlation with stocks and bonds. Often, these commodities perform well under inflationary circumstances as their prices skyrocket. Investors can access a broad basket of commodities via DBC, which uses futures contracts for exposure. This is an advanced fund with high volatility, best suited to risk-tolerant investors. If you do decide to invest, keep an eye out for the end-of-year Schedule K-1 tax form to complete, as DBC is structured as a limited partnership. The ETF is also somewhat costly, with an expense ratio of 0.87%.
iShares Core Aggressive Allocation ETF (AOA)
Investors looking for a hands-off diversified ETF can use asset allocation ETFs like AOA, which is essentially an all-in-one portfolio. The ETF packages global stocks and bonds into a single ticker. By buying AOA, investors no longer need to select individual equity or fixed-income ETFs. AOA automatically picks low-cost options on your behalf in a “fund of funds” structure, allocates them in an 80/20 mix of stocks and bonds, and rebalances the portfolio periodically. This helps investors stay passive and minimize bad behaviors like excessive tinkering or timing the market. AOA costs an expense ratio of 0.15%, and also comes in 60/40 and 40/60 stock/bond versions.
10 best ETFs to build a diversified portfolio:
— Vanguard Total Stock Market ETF (VTI)
— Vanguard FTSE Developed Markets ETF (VEA)
— Vanguard FTSE Emerging Markets ETF (VWO)
— iShares Core U.S. Aggregate Bond ETF (AGG)
— iShares U.S. Treasury Bond ETF (GOVT)
— SPDR Bloomberg 1-3 Month T-Bill ETF (BIL)
— Pimco 1-5 Year U.S. TIPS Index Exchange-Traded Fund (STPZ)
— SPDR Gold MiniShares (GLDM)
— Invesco DB Commodity Index Tracking Fund (DBC)
— iShares Core Aggressive Allocation ETF (AOA)
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Update 10/03/22: This story was published at an earlier date and has been updated with new information.