As Warren Buffett once said, "There seems to be some perverse human characteristic that likes to make easy things difficult."
And for current and future retirees, this raises a question: Can you build a retirement portfolio using only simple exchange-traded funds, or ETFs, like the SPDR S&P 500 ETF Trust (SPY 0.56%), the Vanguard S&P 500 ETF (VOO 0.55%), or even the tech-heavy Invesco QQQ Trust (QQQ 1.55%)?
Or more specifically, should you? Owning individual stocks certainly feels like it offers more potential upside, after all. Here's a reality check.
The statistical odds support simplicity
The question isn't one of logistics; any retirement account that can hold an individual stock can certainly hold an ETF, which trades just like any other exchange-traded ticker. The question is one of performance: Can ETFs compete with stock-picking?
They can. In fact, you may be better off in the long run going this route. Take the aforementioned Vanguard S&P 500 ETF or SPDR S&P 500 ETF Trust, for instance. Meant to mirror the S&P 500 index, these two basic instruments average the same annual gain of about 10% that the underlying index itself does.
That's no disappointing number either, given that most of the mutual funds available to U.S. investors actually underperform the well-known benchmark in almost any time frame. Ditto for hedge funds, and if we're being intellectually honest, most individual investors who trade too often in search of big, quick gains.
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Even if you're talking about ETFs beyond the most basic of index funds, though, the argument for holding them in a retirement portfolio still stands. Vanguard's worst-performing sector-based exchange-traded fund (excluding real estate funds) for the past 10 years is the Vanguard Consumer Staples ETF (VDC +2.53%), yet it still gained more than 60% over the past decade, overcoming industrywide cost headwinds. That return doesn't include any dividends this fund dished out in the meantime, either. Add reinvested dividends to the mix, and the total return improves to over 100% for the past 10 years.
And that's Vanguard's worst-performing sector ETF for this time frame. Buying and holding equally sized stakes in all 10 of Vanguard's core sector funds would have delivered you an average 10-year gain of about 185%. Although you would have fared better with a broader S&P 500 index fund, that's still not a bad overall return for the turbulent decade.
A different mindset is required
The chief challenge here is embracing the mindset that owning ETFs in a retirement portfolio requires. They aren't stocks, which are bought and sold based on their underlying company's potential (or lack thereof). You might hold an individual stock for years on end, or you may dump it in a matter of weeks.
Exchange-traded funds, rather, are theme-based, or even philosophical in nature. In most cases, you'll actually need to stick with these slower-moving instruments for years to make the most rewarding use of them, ignoring short-term headlines and noise along the way. That's easier said than done in an environment that tends to encourage more trading activity than is necessary.
If you can muster the discipline of keeping things simple, though, you may actually fare better than most of your more active fellow investors.
