One of the most counterintuitive yet crucial concepts in investing is diversification. It might seem paradoxical, but combining individually volatile assets that each fluctuate significantly can actually stabilize the overall risk of a portfolio when they are properly mixed.
“For instance, combining stocks and higher-quality investment-grade bonds is much more likely to achieve a higher level of diversification,” says David James, managing director and advisor at Coastal Bridge Advisors. “When stocks go down in value, high-quality bonds often produce positive returns — this is a very basic example of how to build real diversification.”
This smoothing effect is largely due to correlation, or more accurately, the lack of it. By mixing different asset classes — such as stocks, bonds and gold — each responding differently to economic cycles, you end up with a portfolio that behaves like a well-oiled machine, optimizing both risk and return.
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“Different asset classes provide vastly different return profiles during distinct macroeconomic and market environments,” says Michelle Cluver, head of ETF model portfolios at Global X ETFs. “For example, equities and fixed income traditionally have a low correlation, so fixed income can provide a cushion during periods of economic stress where equities are likely to face headwinds.”
For example, from 1972 to the present, a diversified portfolio comprising 70% U.S. stocks, 20% 10-year Treasurys and 10% gold would have delivered competitive returns compared to a 100% U.S. stock portfolio, with an annualized return of 10.1% versus 10.5%.
However, this diversified approach achieved these returns with significantly lower risk — exhibiting an annualized standard deviation (a measure of volatility) of 11.4% compared to 15.8% for the all-stock portfolio and a maximum drawdown (the peak-to-trough loss) of 33.1% versus 50.9%.
Notably, the diversified portfolio achieved a Sharpe ratio (a measure of risk-adjusted return) of 0.51 compared to 0.43 for the 100% stock portfolio. This historical data provides factual proof that diversification is indeed the “only free lunch in investing.”
Today, thanks to exchange-traded funds (ETFs), retail investors can create diversified portfolios extremely easily. ETFs not only allow you to target traditional asset classes like stocks, bonds and gold, but they also provide access to specific sectors, cryptocurrencies like Bitcoin and even hedge-fund-like strategies employing derivatives.
This accessibility transforms sophisticated investment strategies into feasible options for everyday investors, enabling them to build well-rounded, resilient portfolios with ease.
Here are 10 ETFs investors can buy to build a diversified portfolio today:
| Fund | Expense Ratio |
| iShares Core Moderate Allocation ETF (ticker: AOM) | 0.15% |
| iShares MSCI World ETF (URTH) | 0.24% |
| Vanguard Total World Bond ETF (BNDW) | 0.05% |
| iShares National Muni Bond ETF (MUB) | 0.05% |
| SPDR Bloomberg 1-3 Month T-Bill ETF (BIL) | 0.14% |
| SPDR Gold MiniShares Trust (GLDM) | 0.10% |
| iShares Global Energy ETF (IXC) | 0.44% |
| abrdn Physical Precious Metals Basket Shares ETF (GLTR) | 0.60% |
| Invesco S&P 100 Equal Weight ETF (EQWL) | 0.25% |
| SPDR Dow Jones REIT ETF (RWR) | 0.25% |
iShares Core Moderate Allocation ETF (AOM)
“We believe in simplicity, especially for personal investors — we know the biggest decision made is the asset allocation decision, so having a couple of choices for each major asset class is important,” says Adam Grossman, global equity chief investment officer at RiverFront Investment Group. “We also generally stick to U.S. equity, international equity and fixed income.”
AOM is a great example of a one-stop shop, “asset allocation” ETF that puts Grossman’s suggestion into play. This ETF holds a total of seven other iShares ETFs providing exposure to U.S. bonds, U.S. stocks, international developed stocks, international bonds, emerging market stocks, U.S. mid-cap stocks and U.S. small-cap stocks. AOM currently features a 40% equity and 60% bond split with a 0.15% expense ratio.
iShares MSCI World ETF (URTH)
Investors who find AOM’s asset allocation too conservative can choose to invest in its equity and fixed income components separately. For the equity side, a viable option is URTH, which tracks the popular MSCI World Index. Currently, this index features over 1,400 market-cap-weighted equities from both U.S. and international developed markets such as Japan, the U.K., France, Germany, Switzerland and more.
Because the ETF is still market-cap weighted, its top holdings are dominated by familiar U.S. companies such as Microsoft Corp. (MSFT), Apple Inc. (AAPL) and Nvidia Corp. (NVDA). However, in its top 20 holdings investors can also find notable international stocks like Novo Nordisk A/S (NVO) and ASML Holdings NV (ASML). URTH charges a 0.24% expense ratio.
Vanguard Total World Bond ETF (BNDW)
To diversify globally on the bond side, investors can utilize BNDW. This ETF tracks the Bloomberg Global Aggregate Float Adjusted Composite Index. It accomplishes this by holding two other Vanguard bond ETFs that track domestic and international aggregate bonds. In total, holding BNDW will provide you with exposure to over 17,900 government and investment-grade corporate-issued bonds.
Owning BNDW will expose your portfolio to a 6.7-year average duration, a measure of interest rate sensitivity. All else being equal, a 100-basis-point increase in rates will cause BNDW to lose 6.7% in net asset value, but a 100-basis-point decrease in rates will make BNDW rise 6.7%. At present, you can expect a 4.8% yield to maturity, a measure of the total return expected. BNDW charges 0.05%.
iShares National Muni Bond ETF (MUB)
“There are now enough bond ETFs that investors can add for even further diversification,” says Bryce Doty, senior vice president and senior portfolio manager at Sit Investment Associates. “For example, bond investors can tailor their fixed income allocation based on their tolerances for interest rate risk and/or credit quality.” This trait of bond ETFs allows for a high degree of customization when building portfolios.
To capture bonds not covered by BNDW, investors can buy MUB, which holds municipal bonds. “Consider that when COVID-19 shut down businesses, corporate bond default risk spiked, and stocks tanked while there was not much increase in the risk of default for municipal bonds,” Doty notes. Currently, MUB offers a tax-efficient 3.6% yield to maturity for a low 0.05% expense ratio.
SPDR Bloomberg 1-3 Month T-Bill ETF (BIL)
“We caution clients to be careful using long-duration Treasury ETFs to protect against periods of negative stock market returns given their heightened sensitivity to inflation pressures,” Doty says. “As we saw in 2022, the influence of inflation on long-duration bonds trumped all else.” Case in point, the popular iShares 20+ Year Treasury Bond ETF (TLT) fell more than stocks that year, with a 31.4% loss.
By using a shorter-duration bond ETF, investors can minimize the effects of a “higher for longer” interest rate environment and potential upticks in inflation. The ETF to watch for this role is BIL, which tracks the Bloomberg 1-3 Month U.S. Treasury Bill Index. At present, you can earn a virtually risk-free 5.4% yield to maturity with this ETF, along with monthly distributions. BIL charges a 0.14% expense ratio.
[READ: 5 Areas Where Inflation Is Highest]
SPDR Gold MiniShares Trust (GLDM)
Although its purported inflation-fighting characteristics are debatable, gold does have one extremely useful trait when added to a diversified portfolio: a “flight to safety” tendency. For example, during the 2008 financial crisis, gold ended the year with a 4.9% return as investors fled riskier stocks and bonds in search of a safe haven. To access gold, you can buy GLDM at a 0.1% expense ratio.
Today, one of the major catalysts behind rising gold prices is central bank buying pressure. “When Russia invaded Ukraine, the U.S. and European governments confiscated Russia’s foreign exchange reserves of around $500 billion,” says Chris Mancini, associate portfolio manager at Gabelli Funds. “China has $3 trillion of foreign exchange reserves that they don’t want to be confiscated, so they’re diversifying out of dollars into gold, and other central banks around the world are doing that as well because gold cannot be digitally seized or confiscated.”
iShares Global Energy ETF (IXC)
Shares of energy companies have historically been a more reliable inflation hedge than gold, in particular those involved in the exploration and production of oil and gas. For instance, the globally diversified IXC returned 47.8% during 2022’s high inflation environment. For a 0.44% expense ratio, you get access to all five of the “super-major” integrated energy companies in its top holdings.
“We continue to believe that energy companies are an under-appreciated gem in the value space,” Grossman says. “Low oil prices have pushed their break even lower than 10 years ago, and the capital discipline acquired from going through tough markets has focused them on cash flow generation.” IXC also pays a competitive 3.2% 30-day SEC yield on a semi-annual basis.
abrdn Physical Precious Metals Basket Shares ETF (GLTR)
Beyond gold, investors can diversify further with other precious metals subject to different demand drivers. “For example, silver also allows investors to participate in upcoming Chinese stimulus measures, as the metal has a large demand component from industrial use in China,” says Robert Minter, director of ETF investment strategy at abrdn.
To capture gold and silver exposure, investors can buy GLTR, which also holds platinum and palladium in audited vaults for a 0.6% expense ratio. “Platinum and palladium prices have dropped prematurely based on the incorrect view that a transition to fully electric vehicles has already happened,” Minter says. “They are under-appreciated, as they are key components in pollution control for gasoline, hybrid and plug-in hybrid autos, which 80% of the U.S. population still prefers.”
Invesco S&P 100 Equal Weight ETF (EQWL)
Another way investors can diversify is by reducing concentration risk. “For example, the ‘Magnificent 7’ accounted for 60% of the S&P 500’s return in 2023,” says Chris Dahlin, factor and core equity ETF strategist at Invesco. “As a result, the weight of the top 10 companies in the S&P 500 climbed to just over 32%, which is near the highest level of concentration since the late 1970s.”
To sidestep this, investors can buy EQWL. This unique ETF takes all the large-cap stocks found in the lesser-known S&P 100 index and weights each equally at 1% during quarterly rebalances. Historically, it’s been a top performer, achieving a five-star Morningstar rating in the “large value” category of 1,118 competitors. EQWL charges a 0.25% expense ratio.
SPDR Dow Jones REIT ETF (RWR)
Real estate is another asset class investors can use to diversify, and using an ETF can provide much greater liquidity and transparency compared to a rental property. A great example is RWR, which holds 103 domestic real estate investment trusts, or REITs, represented by the Dow Jones U.S. Select REIT Index. Currently, this ETF charges a 0.25% expense ratio and pays a 4.1% 30-day SEC yield.
RWR focuses on the largest and most liquid REITs weighted by market capitalization, with top holdings including Prologis Inc. (PLD), Equinix Inc. (EQIX), Welltower Inc. (WELL), Simon Property Group Inc. (SPG) and Realty Income Corp. (O). Overall, the ETF is broadly diversified across retail, residential, industrial, data center, health care, office, self-storage and hotel REITs.
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10 ETFs to Build a Diversified Portfolio originally appeared on usnews.com
Update 05/02/24: This story was previously published at earlier date and has been updated with new information.
