The Core ETF You Need to Own

This week and last, we're presenting 10 core stock ideas -- stocks our writers believe can serve as the foundation for a long-term-focused portfolio. Today we are presenting a bonus "core" holding, this one an exchange-traded fund.

While individual stock pickers may enjoy the process of researching and monitoring several dozen companies, that approach isn't for everyone. For investors who want to save some time and get wide exposure to the stock market in one shot, a low-cost exchange-traded fund is the way to go. Even stock pickers can benefit from adding a core ETF to their holdings, which will instantly diversify and broaden any portfolio.

The business
Vanguard Total Stock Market ETF (NYSE: VTI  ) is hands-down one of the best core exchange-traded funds for virtually any investor. The fund tracks the MSCI U.S. Broad Market Index, which consists of all domestic stocks on the NYSE and Nasdaq markets. The fund typically holds between 1,200 and 1,300 of the stocks in the target index. You won't leave the market in your dust with this fund, but you will get well-diversified exposure for a next-to-nothing price tag.

Metric

Vanguard Total Market Stock ETF

Fund objective

The fund employs a passive management strategy to track the MSCI U.S. Broad Market Index, which consists of all common U.S. stocks traded on the New York Stock Exchange and Nasdaq over-the-counter market.

Recent price

$57.57

Market capitalization

$14.65 Billion

P/E ratio

7.18

ROE

n/a

Source: Google Finance. ROE = return on equity.

Since its June 2001 inception, this fund has posted an annualized 1% return through August 2010, compared to a completely flat showing for the S&P 500 Index. That isn't a huge difference, but for a passively managed investment that's not aiming to beat that market, that's not too shabby! Turnover is a low 5% here, so the fund can be utilized in both tax-advantaged and taxable accounts without worrying about excessive capital gains.

Vanguard Total Stock Market ETF is a well-rounded fund option that is suitable for investors of all stripes. That's why we recommend the fund in all of the model portfolios we've created in the Fool's Rule Your Retirement investment service. From the youngest, most aggressive investor to gun-shy retirees who shun unnecessary risk, this fund has something for everyone, thanks to its broad mandate.

Why it's a core ETF
When it comes to ETF investing, there are two simple keys to success -- keep it cheap and keep it broad. I recommend folks stay away from narrowly focused, specialized funds that only invest in one particular industry or country, especially if they are leveraged or inverse leveraged funds. Specialty funds like these are not only more risky than most investors need for their portfolio, but they typically come with higher price tags -- in some cases, even higher than most actively managed mutual funds. That's why investors should stick to the ETF basics. Vanguard Total Stock Market meets the criteria for broad and cheap in spades.

If you're looking for inexpensive, wide-market coverage, you won't do much better than this fund. Vanguard Total Stock Market ETF clocks in with a rock-bottom 0.07% expense ratio, the cheapest exchange-traded fund in existence, with only one exception. Another popular broad-market ETF, the SPDR S&P 500 ETF (NYSE: SPY  ) , sports a 0.09% annual price of admission, which isn't a whole lot more than the Vanguard fund, but over time even small fees can add up and eat away at your returns.

The fund invests across the market capitalization spectrum, but as can be expected for a market-cap-weighted index, big-name blue chips tend to take the spotlight. Splashier growth name Apple (Nasdaq: AAPL  ) and value-priced Microsoft (Nasdaq: MSFT  ) from the tech arena stand alongside more staid consumer and health-care stocks such as Procter & Gamble (NYSE: PG  ) and Johnson & Johnson (NYSE: JNJ  ) to provide balanced exposure to the entire stock market . Midsized and small-cap names account for roughly 20% and 6% of assets, respectively.

Risks
The biggest risk involved in owning Vanguard Total Market Stock ETF is market risk. Because the fund contains thousands of names, individual blowups won't affect the portfolio. But macroeconomic conditions and the general market environment will be both the primary drivers and risk factors here. If another market meltdown happens, this fund won't protect you from that carnage.

And while this isn't a risk inherent in owning the fund itself, I think it warrants mentioning that while the fund attempts to capture a wide swath of the domestic stock market, it does emphasize large- and mega-cap stocks rather heavily. So unless you own a handful of individual small-cap stocks elsewhere in your portfolio, you might want to also stock up on another ETF that invests exclusively in small-fry companies, like the Vanguard Small-Cap ETF (NYSE: VB  ) .

In sum
While you can't build a diversified portfolio with just one stock, you can come pretty close to accomplishing that task with just one exchange-traded fund. The Vanguard Total Stock Market ETF is an ideal core holding for any portfolio, thanks to its broad market coverage and low expenses. If you buy just one ETF this year, make it this one.

Amanda Kish is the Fool's resident fund advisor for the Rule Your Retirement investment newsletter. You can start your free 30-day trial today to the service today.At the time of publication, she did not own any of the funds or companies mentioned herein. Apple is a Motley Fool Stock Advisor choice. Microsoft is a Motley Fool Inside Value recommendation. Johnson & Johnson and Procter & Gamble are Motley Fool Income Investor choices. Motley Fool Options has recommended diagonal call positions on Microsoft and Johnson & Johnson. The Fool owns shares of and has written covered calls on Procter & Gamble. The Fool owns shares of Microsoft.

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.


Read/Post Comments (2) | Recommend This Article (9)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 21, 2010, at 1:46 PM, jrmart wrote:

    Great article about ETFs.

    Why should you look at Apple like it's an ETF?

    Because Apple provides a total system solution, not just another ME TOO PRODUCT. This provides Apple stockholders with lots of revenue. Just consider the following facts. From January 2010 to June 2010 Apple sold 11 million handsets worldwide, while Nokia, Samsung and LG sold 400 million handsets. Yet when you look at their % of profits, Apple raked in 39% of the worldwide profits while the combined sales of Nokia, Samsung and LG captured 32% profits. Think about that, the competition sold over 20 times the amount of handsets yet they still earned less than Apple. These facts are based on a Fortune article posted on CNNMONET.com.

    http://tech.fortune.cnn.com/2010/09/21/pie-chart-apples-outr...

    Here is my take on why Apple is so successful and why I consider them an ETF. When Apple introduces a really great innovative product, the rest of the world then responds with ME TOO PRODUCTS. Unfortunately, the rest of the world ME TOO PRODUCTS are not part of a total system. Apple introduced the IPOD and captured 75% of the music world because of ITUNES. Apple introduced the IPHONE and changed the smart phone market through ITUNES and the APP Store by allowing us to download apps. Now Apple introduced the IPAD and ME.COM. ME.COM along with ITUNES provides real time wireless updates of all our contacts, calendars, videos, photos, apps, etc. across all our Apple devices. So Apple is not just another ME TOO PRODUCT company. It is a combination of lots of really great products, software and cloud computing that all communicate real time with each other wirelessly.

    Apples complete wireless system looks like an ETF because just like an ETF it spreads your risk by offering lots of great unique products that really work great together.

  • Report this Comment On September 21, 2010, at 9:33 PM, e320 wrote:

    Can't understand the rec on VTI. 1% return in 10 years isn't my idea of a compelling track record warranting my $. If I had a crystal ball, maybe, but the past ten years should have taught us something.

    e320.

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