If there were a Mount Rushmore of investing advice, the words “make sure you have diversification” would surely be up there. Diversifying company size, sector, and geographic location is important because you don’t want your portfolio to rely on too few factors. There can be upsides to concentrated portfolios, but the downsides are usually much worse (and more likely to happen in the long term).
Ideally, you want a portfolio of at least 25 stocks, but instead of focusing on individual companies, I would invest in exchange-traded funds (ETFs), which allow you to invest in many companies at once. It doesn’t take many ETFs to get the job done, either.
If I had to start from scratch, I would invest $20,000 in these three ETFs.
When in doubt, look to an S&P 500 ETF
Very few stocks cover as much ground as an S&P 500 ETF. Tracking the largest 500 public U.S. companies, the S&P 500 is the most followed index on the stock market, and its performance is often used interchangeably with the stock market’s performance as a whole.
Aside from expense ratio, there’s no tangible difference between S&P 500 ETFs, but you can’t go wrong with the iShares Core S&P 500 ETF (IVV 2.28%), which is low cost and contains companies from all 11 major sectors:
- Communication Services (7.20%)
- Consumer Discretionary (9.66%)
- Consumer Staples (7.30%)
- Energy (5.26%)
- Financials (11.58%)
- Healthcare (15.80%)
- Industrials (8.70%)
- Information Technology (25.52%)
- Materials (2.77%)
- Real Estate (2.72%)
- Utilities (3.22%)
Since the S&P 500 only contains large-cap stocks, it’s not 100% diversified, but it does a good job of giving investors broad-based exposure to larger companies in one investment. And it helps that it contains most industry leaders and blue chip stocks. Therefore, I would let the iShares Core S&P 500 ETF be the foundation of my portfolio and invest $13,000 in it.
Don’t look past the small guys
Because of their size, small-cap companies often have more room for growth than large-cap companies, which can bode well for investors. However, it’s also the small size that makes small-cap stocks more prone to volatility and broader economic conditions. It’s a risk-reward trade-off.
You don’t want all of your portfolio in small-cap stocks because of the risk, but you should have some, or you could be doing yourself a disservice and missing out on high growth potential. I would invest in a broad, small-cap ETF like the Vanguard Russell 2000 ETF (VTWO 2.20%) to lessen the risk.
The Russell 2000 is considered the primary benchmark for small-cap stocks. It has similar status in covering the small-cap stock universe as the S&P 500 has for large-cap stocks.
The Vanguard Russell 2000 ETF is low cost with a 0.10% expense ratio ($1 per $1,000 invested) and contains 1,970 stocks also spanning all 11 major sectors. You probably won’t get the hypergrowth that you could with individual small-cap companies, but you also don’t take on as much risk.
I would invest $3,000 in the Vanguard Russell 2000 ETF.
Leave room for international stocks
A truly well-rounded stock portfolio should include international companies. If you’re only investing in American businesses, you’re missing out on some great companies and investments.
International markets are divided into two categories: developed and emerging. Developed markets typically have advanced economies, established industries, and higher living standards (the U.S., U.K., Japan, and Australia, for example). Emerging markets typically have less infrastructure, younger capital markets, and less stable economies (Mexico, Brazil, Russia, and India, for example). Similar to small-cap stocks, companies in emerging markets are riskier but tend to have more upside as they grow with the market.
Researching individual companies can already be time consuming, but it’s an added layer when you have to factor in things like the local economy and politics, which could make or break a company. Instead of going through that, I’d lean on the Vanguard Total International Stock ETF (VXUS 2.34%), which contains over 7,900 companies in both developed and emerging markets.
With a trailing-12-month dividend yield — the average dividend yield over the past 12 months — of 3.11%, the Vanguard Total International Stock ETF also offers higher amounts of dividend income than the iShares Core S&P 500 ETF (with a current yield of 1.69%) and Vanguard Russell 2000 ETF (yielding 1.48%).
A good rule of thumb is to have 20% of your stock portfolio in international stocks, so I would invest $4,000 to close out the $20,000 total invested.