Can I Diversify My Portfolio With One ETF Rather than Four?
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Q: Does investing in a "total stock market index fund" give you diversified exposure to large-, medium-, and small-sized companies? Or do I need to invest in separate mutual funds for my large- and small-company stocks? — Toby, Davis Junction, IL
A: No, you don't need separate funds. The Vanguard Total Stock Market ETF is designed to give you exposure to a broad cross-section of different types of domestic equities in a single exchange-traded fund.
Its portfolio breaks down like this: around 72% is invested in large companies, a little less than 20% is in medium-sized businesses, about 6% is in small-company shares, and 3% is in so-called micro-cap stocks.
Now, you can achieve similar diversification by allocating your dollars into a collection of more narrowly constructed funds that focus on industry-leading large companies or quick-growing but volatile small companies.
For instance, you could pick up Money 50 funds Schwab S&P 500 Index , with iShares Core S&P Mid-Cap and iShares Core S&P Small Cap . (Although, if you’re not careful, you might end up with more exposure to smaller companies than you want. About 30% of IJR’s portfolio is in micro-cap stocks.)
All things being equal, says BKD Wealth Advisors’ portfolio manager Nick Withrow, you’re better off going with the one fund than three or four.
For one thing, each fund comes with its own expenses. If VTI dovetails with your risk tolerance, then you’ve taken care of your domestic stock portfolio at a measly cost of 0.05% of assets annually. That’s marginally cheaper, by about 0.06 percentage points, than buying a host of exchange-traded funds that collectively approximate VTI’s portfolio, says Withrow.
But there’s another reason — you.
Basically, you don’t want to get into the business of buying and selling ETFs to try and time the market. And you’re much less likely to get into that expensive habit if you buy-and-hold one fund, rather than picking three or four.
“The more choices an investor has, the more apt he or she is to feel that they have to do something,” says Withrow. “The idea of simplicity, especially with a buy-and-hold attitude, goes a long way.”
Of course, one total market exchange-traded fund doesn’t mean your portfolio is complete. Don’t forget about foreign equities or, you know, bonds. But when it comes to U.S. stocks, one cheap total market ETF (like VTI) is particularly useful.