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How to Build an ETF Portfolio

These days, I'm all about simplicity. Between juggling the kids, work and those obligatory social events (another birthday party?!), I'm generally too tired to deal with complications.

That's exactly why creating a portfolio consisting solely of exchange-traded funds has a lot of appeal.

With just a few of these funds, you can have total market coverage with very low expenses, very few tax issues and very little complications.

So are exchange-traded funds the simpler way to go to create a well-rounded portfolio?

It depends.

Ups and Downs of ETFs

When you buy an ETF, you are essentially buying a single security that represents a basket of stocks that track an index. And since the S&P 500 generally beats its actively managed brethren, holding a product that mirrors an index can be a good thing.

But we all know that looks can be deceiving. While ETFs may look like index funds, they actually trade like stocks. So that means you can do a bit more market-timing with your buys and sells since you can trade these things throughout the day. Even better, you can short ETFs, or, if you're audacious enough, buy them on margin.

You can't do any of that with your mutual fund shares.

ETFs' annual expenses are generally very low since the managers don't have a whole lot to do except watch an index all day (how's that for simple?). "Expense ratios are all mostly under 75 basis points," says Michael Iachini, senior research analyst for the Schwab Center for Investment Research. Some are even as low as 10 or 20 points. And with the average actively managed mutual fund hovering at 150 points, or 1.5%, that's a pretty good deal.

And since there's very little change in the indices, ETFs are very tax efficient, as well.

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