How to Put Savings to Work with ETFs

Sometimes the importance of saving gets overlooked when investors think about building wealth — they tend to get caught up in fancy investment portfolios. Saving is a great habit, but stashing the cash in a savings account yielding next to zero makes it tough to grow capital and beat inflation.

Typically, the average savings or money market account is yielding about 1% or less, and the average rate of inflation for last year was 2.1%.

“Within these 1,400-plus product offerings, there are many easy-to-understand ETFs that have the potential to outperform inflation. To yield better results, you have to take on more risk, but some ETFs offer much lower risk than individual stocks. For investors with a longer-term time horizon, these ETFs can build long-term savings better than a savings account or CD,” Tim Parker wrote for Investopedia. [Stock ETFs Rally as Investors Return to Risky Assets]

According to a recent Charles Schwab study, 44% of investors intend to use more ETFs in their portfolios this year. In order to beat the rate of inflation, investors will need to put their money into a long term equity strategy, or for those who are more conservative, bond ETFs are also a choice. Index ETFs are can be used as a core holding within a portfolio. The following equity ETFs are ideal, according to the report:

• SPDR S&P 500 (SPY): This broad based index fund tracks the S&P 500 and is very affordable at 0.09%. There is a 2.1% dividend yield. Over the past 5 years the ETF has quadrupled the performance of the average savings account, reports Parker.

• iShares Russell 2000 Value Index (IWM) This ETF is ideal for the best small-cap exposure. It has a 0.2% expense ratio and a 2% dividend yield.

• Vanguard Total Stock Market (VTI) This ETF tracks an index made up of companies from the NASDAQ Index and the New York Stock Exchange. It is a broad sampling of the entire US stock market. A 0.05% expense ratio and a 2.1% dividend yield. [Investors Bullish on Stock ETFs as S&P 500 Nears All Time High]

Bond ETFs are a good supplement for those investors who are more conservative or are older in age. As retirement comes closer, some investors taper down their risk exposure while adding in more stable tools. The following ETFs invest in hundreds or even thousands of bonds at once, which adds diversification and more risk mitigation:

• iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) The high yield nature of the bonds held in this portfolio give higher returns, but also entail more risk. All of the bonds are highly rated, so default is highly unlikely. The 3.1% yield is pared nicely with the 0.15% expense. [2012 Was the Year of the Bond ETF]

• iShares iBoxx $ High Yield Corporate Bond ETF (HYG) High yield corporate bonds are a nice addition to a bond strategy and also add nice diversification.

Tisha Guerrero contributed to this article.

Full disclosure: Tom Lydon’s clients own SPY, IWM, LQD, HYG.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.