{"id":16,"date":"2007-02-08T15:37:50","date_gmt":"2007-02-08T20:37:50","guid":{"rendered":"https:\/\/stockherd.com\/blog\/?p=16"},"modified":"2007-07-08T21:31:26","modified_gmt":"2007-07-09T02:31:26","slug":"etf-and-index-investing","status":"publish","type":"post","link":"https:\/\/stockherd.com\/blog\/?p=16","title":{"rendered":"ETF and Index Investing"},"content":{"rendered":"

While selecting stocks and building a solid portfolio can be rewarding, not everyone has the time or interest to do so. Also, core portfolio assets (e.g.<\/span>, the money you need to retire) deserve special protection. Index funds and exchange traded funds (ETFs) make it possible to build a diversified, tax efficient portfolio that requires little maintenance beyond periodic (quarterly or annual) rebalancing. Using ETFs or index funds to diversify among several asset classes increases the long term rate of return and reduces portfolio risk.<\/p>\n

An index fund is a mutual fund consisting of stocks that correspond with a market index. An ETF is a stock certificate reflecting underlying assets that correspond with a market index. Index funds are bought and sold like mutual funds, i.e.<\/span>, at the end of each trading day. ETFs trade continuously traded throughout the business day on the major exchanges like other stocks.<\/p>\n

Index funds can be purchased through some of the large family of funds. Vanguard and Fidelity offer a wide range of low cost index funds. You also can purchase index funds through a broker, but this usually results in a brokerage fee. Since ETFs are traded as stocks, they can be purchased through any broker. While there is a brokerage fee for purchasing ETFs, there is no minimum dollar amount or number of shares. Since they are mutual funds, index funds require some minimum purchase. For smaller portfolios, it may be easier to diversify using ETFs.<\/p>\n

What goes into a portfolio of ETFs or index funds? There are many different views on this but, typically, the portfolio is divided into three or more asset classes. This might include domestic stocks (30-50%), international stocks (20-40%), REITs (10-20%), and bonds (20-40%). A simple portfolio might include a broad market index such as the Vanguard Total Stock Market Index<\/a> (40%), a broad international stock index such as the Morgan Stanley MSCI EAFE<\/a> (40%), and a bond index such as the Lehman U.S. Aggregate index<\/a> (20%). A portfolio of just these three indices provides decent diversification.<\/p>\n

Depending on the amount of money to be invested, the major asset classes can be further subdivided. For example, the 40% in domestic stocks about be further divided as follows: total market index (10%), large cap blend (10%), mid cap blend (10%), and small cap blend (10%). (A blend includes both growth and value stocks). The domestic equities can be skewed toward a value style by selecting value funds instead of blended funds for each of the various market caps, or each market cap could be split between value and blended indices. Similarly, the international component can be subdivided among European, Pacific, and emerging or developing markets.<\/p>\n

Including a bond component such as the Lehman U.S. Aggregate Index<\/a> reduces risk (volatility) but with a slight decrease in long term return. The longer the time horizon, the smaller the bond component. See XTF “Efficient Frontier” chart<\/a> for graphical presentation of the relationship between asset mix and return.<\/p>\n

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It is much easier to set up a diversified portfolio of ETFs or index funds, than to describe it here. Here are several links to good articles about index investing:<\/p>\n