Contrary to popular belief, achieving diversification in investing goes beyond simply not “putting all your eggs in one basket.” Owning shares in multiple companies doesn’t necessarily mean an investor’s portfolio is diversified.
For real diversification, a broader approach is essential — one that spans various asset classes including bonds, cash, commodities, precious metals and even alternative investments.
“Different asset classes provide vastly different return profiles during distinct macroeconomic and market environments,” explains 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.”
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This concept of diversification is made possible through the often low or even negative correlation between different asset classes. Think of it like this: When one asset class takes a dip or ‘zag,’ others might climb or ‘zig,’ counterbalancing the portfolio’s overall risk.
“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.”
Basically, a diversified portfolio can be thought of as a well-equipped boat, designed with various features to navigate through different types of storms — stocks to propel growth during bull markets, bonds to provide stability through economic downturns, commodities to hedge against inflation and cash to offer security when all else is uncertain.
Here are 10 exchange-traded funds (ETFs) investors can buy to build a diversified portfolio:
| ETF | Expense ratio |
| iShares Core Moderate Allocation ETF (ticker: AOM) | 0.15% |
| Vanguard Total World Stock ETF (VT) | 0.07% |
| iShares Core U.S. Aggregate Bond ETF (AGG) | 0.03% |
| SPDR Bloomberg 1-3 Month T-Bill ETF (BIL) | 0.14% |
| iShares MSCI Global Energy Producers ETF (FILL) | 0.39% |
| Direxion Auspice Broad Commodity Strategy ETF (COM) | 0.80% |
| Alpha Architect Tail Risk ETF (CAOS) | 0.63% |
| iMGP DBi Managed Futures Strategy ETF (DBMF) | 0.85% |
| Avantis U.S. Small Cap Value ETF (AVUV) | 0.25% |
| WisdomTree U.S. Efficient Core Fund (NTSX) | 0.20% |
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.”‘
Investors can put Grossman’s advice into play via a one-ticker “asset allocation” ETF like AOM. This ETF uses a “fund of funds” structure to encompass multiple other iShares ETFs, giving it a fairly conservative split of 40% in global equities and 60% in global fixed income. The ETF is professionally managed and periodically rebalanced back to this target allocation. AOM charges a 0.15% expense ratio.
Vanguard Total World Stock ETF (VT)
Investors who don’t mind additional complexity and some hands-on management can reduce costs further by constructing their own portfolio. For the equity allocation, a great ETF to use is VT. This Vanguard ETF tracks the FTSE Global All Cap Index, which currently holds over 9,900 U.S., international developed and emerging market equities for an affordable 0.07% expense ratio.
By using VT, investors can alter the mix of stocks and bonds in their portfolio more precisely versus an asset allocation ETF like AOM. It also saves investors the need to combine separate equity ETFs for U.S. and international market exposure. The market-cap-weighted nature of VT means that no matter what country ends up outperforming, investors will be able to capture its performance in a low-cost manner.
iShares Core U.S. Aggregate Bond ETF (AGG)
“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.” For a one-size-fits-all bond ETF, investors can buy AGG.
AGG’s benchmark, the Bloomberg U.S. Aggregate Index, is the go-to standard for capturing the domestic investment-grade bond market. It includes over 11,990 Treasurys, mortgage-backed securities and corporate bonds with an intermediate interest rate sensitivity and an average 4.2% yield to maturity. As an iShares “Core” ETF, AGG is also extremely affordable, with a low 0.03% expense ratio.
SPDR Bloomberg 1-3 Month T-Bill ETF (BIL)
Not all types of bond ETFs are designed to offer investors safety of principal. “For example, 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.”
For a true safe asset, investors can add an allocation to BIL in a portfolio. This ETF tracks the Bloomberg 1-3 Month U.S. Treasury Bill Index, giving it excellent credit quality and low interest rate sensitivity. Even with the recent 50-basis-point cut in interest rates from the Federal Reserve, BIL is still paying a competitive 4.7% yield to maturity with monthly distributions. The ETF charges a 0.14% expense ratio.
iShares MSCI Global Energy Producers ETF (FILL)
“We continue to believe that energy companies are an underappreciated 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.” As seen in 2022, energy companies can be a potent hedge against inflation.
For global exposure to energy stocks, investors can buy FILL, which tracks the MSCI ACWI Select Energy Producers Investable Market Index. This ETF is dominated by the five “super-major” companies, also known as Big Oil — Exxon Mobil Corp. (XOM), Chevron Corp. (CVX), Shell PLC (SHEL), BP PLC (BP) and TotalEnergies SE (TTE). But it also includes hard-to-access stocks like Saudi Arabian Oil Co. (2222.SR) and PetroChina Co. Ltd. (0857.HK).
[See: 7 Best Energy ETFs to Buy Now]
Direxion Auspice Broad Commodity Strategy ETF (COM)
Energy equities have inflation sensitivity, but not as much as pure commodities, as they are still subject to the risks of being stocks. For direct inflation protection, investors can use a commodity futures ETF like COM. This ETF tracks the Auspice Broad Commodity Index, which provides exposure to a basket of 12 different commodity futures contracts for a 0.8% expense ratio and has no K-1 form.
Currently, COM’s exposure can include agriculture, energy and metals. However, COM’s strategy goes beyond just going long on commodities. The ETF uses a trend-following strategy to mitigate the cyclical nature of the commodities market. If the ETF’s model signals a downtrend, COM can take a “flat” position by holding cash instead of just enduring the loss.
Alpha Architect Tail Risk ETF (CAOS)
“Tail risk” refers to the risk of rare events that lie on the extreme ends of a probability distribution curve, which can have a severe impact on portfolios. For example, the global financial crisis of 2008 or the COVID-19 market crash in 2020 are instances where unforeseen events triggered significant market downturns. To manage such tail risks, investors often turn to strategies that can hedge against these.
Enter CAOS. This ETF employs a complex, quantitatively driven options overlay strategy, utilizing put spreads to provide portfolio insurance. However, it’s not just about the potentially positive returns during a crash, aka “crisis alpha.” CAOS is also structured to minimize “negative carry,” a condition where the cost of holding a tail risk hedge steadily erodes returns during normal circumstances.
iMGP DBi Managed Futures Strategy ETF (DBMF)
Despite their high costs, many institutional and high-net-worth investors favor hedge funds for diversification. This is because their strategies allow for potentially uncorrelated returns with major asset classes like stocks and bonds, which can enhance risk-adjusted performance. But thanks to ETFs, investors can also access fairly sophisticated hedge fund strategies. A great example is DBMF.
This ETF is able to take long and short positions via futures and forward contracts across a wide range of asset classes, including equities, fixed income, currencies and commodities. It uses a quantitatively driven model to basically “reverse engineer” the composition and returns of the SG CTA Index, a benchmark of major commodity trading advisors. DBMF charges a 0.85% expense ratio.
Avantis U.S. Small Cap Value ETF (AVUV)
Most equity ETFs are market-cap-weighted — the larger a company’s size is, the more weight it is assigned. This results in broad market indexes like the S&P 500 possessing a tilt toward large-cap stocks with growth traits. To balance this out, investors can add an allocation to a small-cap value ETF like AVUV, which offers active management at a reasonable 0.25% expense ratio.
This ETF uses the principles of factor investing, which hold that over the long term, smaller and undervalued companies should outperform. Over the past three years, AVUV has delivered this outperformance, returning an annualized 10.2% versus the 3.1% for the Russell 2000 Value Index. It is one of the most popular small-cap value ETFs, with over $13.6 billion in assets under management.
WisdomTree U.S. Efficient Core Fund (NTSX)
One problem investors may run into while trying to diversify their portfolio is running out of room. To address this, consider using a capital-efficient ETF like NTSX. This ETF combines a core position of 90% in U.S. stocks and 10% in Treasury futures, the latter of which produces six-times leverage. This gives NTSX an overall exposure of 90% stocks and 60% bonds, making it a leveraged ETF.
To use NTSX effectively, consider allocating it as 67% of a portfolio. This produces comparable exposure to classic 60/40 portfolios. However, by doing this investors can free up 33% to allocate toward other diversifiers. For instance, a portfolio of 67% NTSX and 33% DBMF will provide an asset allocation of 60% in stocks, 40% in bonds and 33% in hedge fund strategies. NTSX charges a 0.2% expense ratio.
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Update 09/24/24: This story was previously published at an earlier date and has been updated with new inforamtion.
