Exchange-traded funds have made investing a lot easier for many investors. Unfortunately, the massive explosion in the number of ETFs available has made choosing the right ETF anything but simple. By sticking to the basics, though, you can put together exactly the portfolio you need to meet all of your financial goals.
Later on in this article, I'll show you five ETFs that give you nearly everything you need in order to build wealth. But first, let's take a look at how the world of ETFs has gone from a tiny backwater of the investing universe to one of its most popular and fastest-growing areas.
The Wild West of investing
When ETFs first came out in the 1990s, they didn't cover any new ground. For the most part, they mirrored mutual funds that already gave exposure to stock indexes like the S&P 500 that the first ETFs tracked. Their primary benefit came from investors being able to buy and sell them during the day, rather than having to wait until the market close to lock in a price. In volatile markets that often saw big intraday swings, getting a few hours' jump on the competition could make a huge difference.
As ETFs caught on, though, they started to take investors into areas of the investing world that they hadn't previously been able to reach. The ensuing proliferation of ETFs has made the ETF universe look like the final frontier of the financial world, as ETF companies fight to muscle into increasingly crowded niches in search of gold and glory.
But in the land grab of ETFs, we've largely lost their initial goal of making things simple. Fortunately, as long as you can avoid getting waylaid by the allure of top money-making funds, picking the right ETF portfolio isn't too difficult.
What you don't need
The complicated ETFs that have come out in recent years certainly promise to bring you riches. But many of them have fundamental flaws that are more likely to take your money than to build it.
For instance, commodity-tracking funds like United States Natural Gas (NYSE: UNG ) have what look like simple objectives: Help investors track the changes in key commodities. Yet despite their popularity, commodity ETFs that use futures to track prices are vulnerable to adverse conditions in the futures markets that sap returns over the long haul.
Similarly, leveraged ETFs such as ProShares Ultra Silver (NYSE: AGQ ) and ProShares Ultra Real Estate (NYSE: URE ) promise outsized returns when markets make big moves in your direction. But if you try to use them for long-term investing, you'll find that often, both bullish and bearish leveraged ETFs can lose money.
Stick to the basics
Instead of getting caught up in exciting funds that can cost you a secure retirement, it makes more sense to steer clear of excitement in favor of boring yet consistent performers. Here are five you should strongly consider:
1. Schwab U.S. Broad Market (NYSE: SCHB ) gives you a piece of 2,500 stocks in the Dow Jones index that this ETF tracks. With a rock-bottom expense ratio that even puts Vanguard to shame, this fund demonstrates its commitment to keeping costs as low as possible -- which is crucial for your long-term investing success.
2. iShares MSCI EAFE (EFA) opens the borders of your portfolio to international investment. With developed-market investments from around the world, you can set your allocation between domestic and international stocks to fit your needs.
3. Vanguard MSCI Emerging Markets (NYSE: VWO ) fills in the gaps by bringing emerging market investments into the equation. With a far lower expense ratio than its iShares counterpart, the Vanguard ETF gives you a play on the prospects for the world's fastest growing economies.
4. SPDR Barclays High Yield Bond (NYSE: JNK ) provides some fixed-income assets for your portfolio, but these aren't bonds for the meek. As the ticker suggests, this ETF owns junk bonds. But while junk bonds have significant default risk, even ultra-safe Treasury bonds have plenty of interest rate risk if the bond market starts pushing yields back upward.
5. Vanguard REIT ETF (NYSE: VNQ ) brings real estate into your portfolio with a diversified portfolio of real estate investment trusts. Yields aren't as high as they once were, but if real estate rebounds, you could find big gains here.
Don't be tricked
A portfolio of five ETFs may seem too simple to be good. But the best thing about ETFs is that you can build portfolios easily and effectively with relatively few funds. By mixing and matching these funds -- and perhaps spicing up your portfolio with small purchases of more specialized ETFs -- you can put yourself in position to achieve all of your financial dreams.
For some ideas on ETFs with some spice to them, check out The Motley Fool's special free report on ETFs. You'll find three great funds to help boost your core portfolio's returns.
Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance.