One of the key pillars of investing is diversification. You should aim for companies of different sizes, industries, and locations. Achieving this type of diversification by investing in individual companies is no easy feat, though. The time it'd take to research all those companies effectively is a big enough deterrent for many investors, including myself.
That's why I'd lean on a few broad exchange-traded funds (ETFs) -- which are funds that contain other stocks and bonds -- to achieve diversification if I could start from scratch. With these four ETFs, achieving a well-diversified portfolio and setting a good investing foundation is possible.
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Can't leave out the small companies
A small-cap company has a market cap between $300 million and $2 billion, and they're generally viewed as high-risk, high-reward investments. Due to their small size and fewer resources, they're more susceptible to volatility and broader economic conditions, but this smaller size also leaves room for lots of growth. And where there's room for lots of growth, there's room for investors to make a lot of money.
To cover lots of ground and lessen some of the inherent risks, I'd invest in a Russell 2000 ETF like the Vanguard Russell 2000 ETF (VTWO -0.23%). The Russell 2000 tracks the smallest 2000 companies in the Russell 3000 index and is viewed as the primary benchmark for small-cap stocks.
The Vanguard Russell 2000 ETF contains more than 1,950 companies covering all major sectors, so it checks off all the boxes. It's also low-cost, with a 0.10% expense ratio. I would invest $2,000 here (10%).
It's nice to have a balance
Mid-cap companies have a market cap between $2 billion and $10 billion. These companies can be the sweet spot in the middle: just large enough to have more resources and a bit more stability, but still small enough that there are lots of growth opportunities. You may not have the huge upside with mid-cap stocks that you would with low-cap stocks, but you also don't have as much risk.
I would invest $2,000 (10%) in the Vanguard Mid-Cap ETF (VO -0.22%) because of its low cost (0.04% expense ratio) and diversification. The ETF contains more than 340 stocks from all major sectors, with none accounting for more than 16% of the fund. For comparison, information technology companies account for over 26% of the S&P 500 index.
Lean on the ol' faithful
Of all the indexes in the stock market, none compare to the S&P 500 in popularity or importance. Tracking the largest 500 public U.S. companies, the S&P 500 has become the baseline for the stock market and broader economy's performance.
If one investment had to be the staple of my portfolio, it would undoubtedly be an S&P 500 ETF because of the boxes it checks off: diversification, blue chip companies, and historically good long-term returns. For all intents and purposes, an investment in the S&P 500 is an investment in the U.S. economy.
Since there's no real tangible difference between S&P 500 ETFs other than fees, I would invest $12,000 (60%) in the Vanguard S&P 500 ETF (VOO -0.86%) because of its low cost (0.03% expense ratio). For perspective, that's less than a third of the cost of the SPDR S&P 500 ETF Trust (SPY -0.90%) at 0.0945%.
Look outside the U.S.
You can't have a completely diversified stock portfolio by only investing in U.S. companies. You'd also be doing yourself a disservice if you did, because there are many great companies worldwide. International markets are either considered developed or emerging. Developed markets have more advanced and stable economies, while emerging markets generally have newer markets and less infrastructure.
Emerging markets are like small-cap stocks in that they're higher risk, higher reward, so you don't want to ignore them. The challenge with investing in international companies can be the other factors you need to consider outside of the business itself, such as local politics.
I'd invest the remaining $4,000 (20%) in the Vanguard Total International Stock ETF (VXUS -0.10%) because it includes more than 7,900 companies from both developing and emerging markets:
- Emerging: 25.3%
- Europe: 40.1%
- Pacific: 26.7%
- Middle East: 0.5%
- North America: 7.4%
Having around 20% of your stock portfolio in international stocks is a good rule of thumb to follow for most investors.
