Because ETFs trade like stocks, you have to pay a commission fee every time you buy or sell a piece of these things -- just like you would a regular stock trade. So if you're planning on making monthly contributions to your portfolio, ETFs might not hold an advantage over regular funds.
In addition, if you're looking to beat the market as opposed to just keeping pace with it, you'll probably want to go with individual stocks or actively traded mutual funds, says Iachini.
Who Can Benefit From ETFs?
If you came into a big chunk of change and are just planning on dumping it into a taxable account, with no real intention of trading that money, these things could work for you, says Dan Culloton, a senior fund analyst at Morningstar.
In short, you want to buy 'em and hold 'em.
But ETFs can also be a great way to add some sector exposure to your portfolio, says John Sweeney, senior vice president, Fidelity Personal Investments. Let's say you don't have enough health care exposure in your portfolio. You could consider the
Health Care Select Sector SPDR
, which tracks the S&P 500 health care sector, and be covered with one purchase.
You could also try using ETFs the way the pros do -- as a parking lot for excess cash. ETF shares can easily be converted back to cash and don't have short-term redemption fees like many funds do. So you won't have to pay an early withdrawal charge because you withdrew the money before a specified time. You will be hit with commissions on the buy and sell, though, so make sure the amount is large enough to justify those fees.
Build an ETF Portfolio
So let's presume ETFs could work for you. What should go in your ETF portfolio?
Start with a basic diversification that would give you broad U.S. and international exposure, including some emerging markets plays, as well as some fixed income, depending on your risk tolerance, says Culloton. If you're a risk taker and have time on your side, you probably could afford to go all-equities. If not, Culloton recommends that 10% to 30% be in fixed income.
For your U.S. exposure, the
Vanguard Total Stock Market VIPERs
iShares S&P 500 Index
are relatively cheap. The
iShares Russell 3000 Index
is also worth checking out, since its expense ratio is just 0.20%.
On the international front, consider the
iShares MSCI EAFE Index Fund
, suggests Culloton. This ETF mirrors the Morgan Stanley Capital International Europe, Australia and Far East Index (MSCI EAFE) index and is composed of about 1,000 companies that trade on 20 stock exchanges around the world (not including the USA, Canada, and Latin America). Can't get much more international than that. For emerging markets, there's the
Vanguard Emerging Markets Stock VIPERs
, which is cheaper than its iShares counterpart.