It's possible to construct a winning long-term investment strategy with just low-cost index funds.
While I'm an avid individual stock investor, it's important not to overlook the wealth-creation potential of low-cost exchange-traded funds (ETFs). They can be a great supplement to a portfolio of individual stocks or a great way to invest all by themselves -- especially the low-cost index fund variety.
With that in mind, if I could only use five ETFs to create an investment portfolio to last for decades, here's a list of the funds I'd choose.
The five index funds I'd use to create a portfolio
There's no perfect combination of five ETFs. I'm generally a fan of Vanguard's funds due to their low costs, but there are great ETFs from other companies, such as Charles Schwab, BlackRock, and others.
If I were to form a long-term investment portfolio using only a handful of ETFs, I'd want to use a general S&P 500 index fund to form a portfolio "backbone." I'd also want exposure to small-cap stocks, international stocks, and fixed income. So here are the five Vanguard ETFs I'd use:
- The Vanguard S&P 500 ETF (VOO 0.68%) is an , aiming to match the returns of the benchmark index over time. Since 1965, the S&P 500 has averaged a 10% annualized return.
- The Vanguard Small-Cap ETF (VB 0.99%) gives exposure to smaller companies. The S&P 500 is a weighted index of large-cap stocks, so its performance mainly depends on the largest U.S. corporations. This one adds small caps, giving more diversified exposure to the U.S. stock market than an S&P 500 index fund alone.
- The Vanguard International Stock ETF (VXUS 0.80%), as the name implies, invests in an index of companies based outside of the United States. I'm a fan of having some international exposure, and a basic index fund like this can be a great way to get it.
- The Vanguard Real Estate ETF (VNQ 0.07%) adds diversification and income to the portfolio. This is an index fund mainly composed of real estate investment trusts, or REITs. Not only do these stocks pay above-average dividends, but they tend to be less volatile than the S&P 500.
- Finally, the Vanguard Total Bond Market ETF (BND 0.11%) tracks an index of fixed-income securities (bonds) with exposure to corporate and government bonds of various maturity lengths. Fixed-income securities tend to provide consistent income and aren't nearly as volatile (generally) as the stock market.
How I'd allocate my money
As a general rule of thumb, I subtract my age from 110 to determine the percentage of my assets that should be in stocks, with the rest in fixed income investments. I'm in my early 40s, so this means that I should keep about 70% of my money in stocks. I tend to think I have a somewhat high level of risk tolerance, so my actual stock allocation is closer to 80%.
Of the five index funds I listed, four are stock-based ETFs. I'd put about half of my stock allocation in the S&P 500 index fund, with the rest equally divided among the other four. But it's important to periodically take stock of how your investments have performed, as well as your age, and rebalance accordingly.
How much can you expect from a strategy like this?
There's no way to accurately predict how any investments will do, especially over shorter periods. The stock market has historically produced returns of about 10% annualized over multidecade periods, and fixed-income investments have historically produced total returns in the 4%-5% annualized range.
It's reasonable to expect a long-term rate of return of around 7% from a balanced strategy like this. To put this into perspective, if you start when you're 30 and invest $5,000 annually into an index fund portfolio like this averaging 7% annualized returns, you'd have about $700,000 by the time you're 65. If you start when you're 25, this simple, hands-off strategy could allow you to retire a millionaire.
As Warren Buffett said, "It is not necessary to do extraordinary things to achieve extraordinary results." And that's true in investing if you have two things -- rock-solid ETFs and time.
Charles Schwab is an advertising partner of The Ascent, a Motley Fool company. Matt Frankel has positions in Vanguard S&P 500 ETF and Vanguard Specialized Funds - Vanguard Real Estate ETF. The Motley Fool has positions in and recommends Charles Schwab, Vanguard Bond Index Funds - Vanguard Total Bond Market ETF, Vanguard Index Funds - Vanguard Small-Cap ETF, Vanguard S&P 500 ETF, Vanguard Specialized Funds - Vanguard Real Estate ETF, and Vanguard Star Funds - Vanguard Total International Stock ETF. The Motley Fool recommends the following options: short June 2024 $65 puts on Charles Schwab. The Motley Fool has a disclosure policy.
FAQs
The Motley Fool has positions in and recommends Charles Schwab, Vanguard Bond Index Funds - Vanguard Total Bond Market ETF, Vanguard Index Funds - Vanguard Small-Cap ETF, Vanguard S&P 500 ETF, Vanguard Specialized Funds - Vanguard Real Estate ETF, and Vanguard Star Funds - Vanguard Total International Stock ETF.
How many ETFs should you hold in a portfolio? ›
Experts agree that for most personal investors, a portfolio comprising 5 to 10 ETFs is perfect in terms of diversification.
Is 5 ETFs enough? ›
Generally speaking, fewer than 10 ETFs are likely enough to diversify your portfolio, but this will vary depending on your financial goals, ranging from retirement savings to income generation.
Is 5 stocks enough for a portfolio? ›
Target How Many to Own – By holding a sufficient number of stocks, you can reduce the variation of the portfolio's performance. We recommend owning a minimum of 15 stocks to reduce the volatility of returns in your overall portfolio.
What is the 5% portfolio rule? ›
This rule suggests that investors should not allocate more than 5% of their portfolio in any one stock or investment. The idea behind this rule is to limit the potential risk to the overall portfolio if one investment does not perform as expected.
What is the 4% rule ETF? ›
Known as the 4% rule, Bengen argued that investors could safely set their annual withdrawal rate to 4% of their initial retirement pot and adjust it for inflation without running out of money over a 30-year time horizon.
Is 7 ETFs too many? ›
"You can get broad-based diversification with one ETF, commonly referred to as diversified ETFs, or you can build a portfolio of five to 10 ETFs that would offer good diversification," he says. The choice you make on the above depends on your investment goals and risk appetite, like any investment.
What is the 3 5 10 rule for ETF? ›
Specifically, a fund is prohibited from: acquiring more than 3% of a registered investment company's shares (the “3% Limit”); investing more than 5% of its assets in a single registered investment company (the “5% Limit”); or. investing more than 10% of its assets in registered investment companies (the “10% Limit”).
Should you invest in multiple ETFs or just one? ›
You don't have to choose just one. Once you know the basics of ETFs, you can consider building an all-ETF portfolio that meets your tolerance for risk and your financial goals while retaining the low investing fees that made ETFs so popular in the first place.
How many S&P 500 ETFs should I buy? ›
SPY, VOO and IVV are among the most popular S&P 500 ETFs. These three S&P 500 ETFs are quite similar, but may sometimes diverge in terms of costs or daily returns. Investors generally only need one S&P 500 ETF.
A stock portfolio focused on dividends can generate $1,000 per month or more in perpetual passive income, Mircea Iosif wrote on Medium. “For example, at a 4% dividend yield, you would need a portfolio worth $300,000.
How much money do I need to invest to make $3,000 a month? ›
Imagine you wish to amass $3000 monthly from your investments, amounting to $36,000 annually. If you park your funds in a savings account offering a 2% annual interest rate, you'd need to inject roughly $1.8 million into the account.
What is the ideal number of stocks to have in a portfolio? ›
How many different stocks should you own? The average diversified portfolio holds between 20 and 30 stocks. The Motley Fool's position is that investors should own at least 25 different stocks.
How much of my portfolio should be in ETFs? ›
"A newer investor with a modest portfolio may like the ease at which to acquire ETFs (trades like an equity) and the low-cost aspect of the investment. ETFs can provide an easy way to be diversified and as such, the investor may want to have 75% or more of the portfolio in ETFs."
What is a lazy portfolio? ›
A Lazy Portfolio is a collection of investments that requires very little maintenance. It's the typical passive investing strategy, for long-term investors, with time horizons of more than 10 years. Choose your investment style (Classic or Alternative?), pick your Lazy Portfolios and implement them with ETFs.
How many funds is too many in a portfolio? ›
You should therefore only keep as many funds in your portfolio as you're comfortable monitoring. For example, if you hold 10 or 20 different funds, you'll need to keep a close eye on the changing value of all these investments to make sure your asset allocation still matches your investment goals.
What is the rule of 40 in ETF? ›
What is the Rule of 40? The Rule of 40 states that, at scale, the combined value of revenue growth rate and profit margin should exceed 40% for healthy SaaS companies. The Rule of 40 – popularized by Brad Feld – states that an SaaS company's revenue growth rate plus profit margin should be equal to or exceed 40%.
What is the 70 30 ETF strategy? ›
This investment strategy seeks total return through exposure to a diversified portfolio of primarily equity, and to a lesser extent, fixed income asset classes with a target allocation of 70% equities and 30% fixed income. Target allocations can vary +/-5%.
What is the 30 day rule on ETFs? ›
Q: How does the wash sale rule work? If you sell a security at a loss and buy the same or a substantially identical security within 30 calendar days before or after the sale, you won't be able to take a loss for that security on your current-year tax return.
