Sophistication Is Overrated

 | Apr 13, 2012 | 11:00 AM EDT
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There are now more than 1,400 U.S. exchange-traded products, and that figure continues to grow rapidly, with new funds beginning trade sometimes on a daily basis. A significant portion of my day is spent evaluating trends in the markets and seeking to tie current events to some of the more targeted and precise ETFs out there. The granularity of the exchange-traded world has increased tremendously over the past several years; there is now an ETF for just about every asset sub-class and precise investment strategy. That means investors with strong opinions on certain narrow segments can use ETFs to play them, potentially turning significant profits in a relatively short period.

Sometimes, it's helpful to take a big step back and approach things from a higher level. While there are countless short-term opportunities among the current lineup of ETFs, it is perhaps more useful for many investors to focus in on some of the broader funds out there -- ones that can be useful as cornerstones of a long-term buy-and-hold portfolio. Though many of the "first generation" of ETFs were originally designed with these types of investors in mind, a growing number of products now on the market are ideal for those looking to make tactical allocations to a particular asset class, or a short-term bet for or against a particular section of the investable universe.

If you're looking for an actionable idea that can be executed today or even this week, the rest of this column might not be all that interesting. But if you're looking to build a long-term, low cost buy-and-hold portfolio, read on.

I'm of the strong opinion that sophistication is often overrated. Many of the most important ETFs in my portfolio -- those that make up the core holdings -- are really quite simple. One of those is the Vanguard Total Market ETF (VTI), which tracks the MSCI U.S. Broad Market Index. VTI has just about everything you could want from an ETF that's a core holding in a long-term portfolio. It's incredibly cheap, with an annual management fee of just 7 basis points, and is also available commission-free on both Vanguard and TD Ameritrade platforms.

The portfolio is both deep and balanced. VTI has more than 3,000 individual holdings, and the top 10 make up only about 17% of the total portfolio. Though it's tilted toward large-cap stocks, also getting meaningful allocation are mid-caps and small-caps. Further, every sector of the market is represented, with seven different sectors making up at least 10% of total assets.

As with many other ETFs, VTI is also extremely tax-efficient. Further, this fund trades at penny-wide spreads throughout the day, meaning that you can exit at just about any time for a fair price. There are other ETFs out there with substantially similar features, but none that quite bring together all that VTI has to offer.

I'm not suggesting that anyone use VTI as the sole source of equity exposure in their portfolio. Personally, I maintain a number of other satellite positions that have the intent of capturing alpha from timely developments in financial markets. But, as far as core holdings go, it's tough to ignore VTI. An allocation of 10% to 30%, depending on your individual circumstances, immediately delivers access to thousands of stocks of all shapes and sizes, and ensures that your portfolios should have reasonably low overall management fees.


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