What to Look for in a ‘Core’ ETF Investment Portfolio

When constructing a well diversified exchange traded fund portfolio, it is important to maintain strong “core” allocations before diverging off the beaten path.

“Ideal strategic ‘core’ portfolios give broadly diversified exposure to an entire asset class,” according to Morningstar analyst Michael Rawson. “Highly correlated securities with similar risk and return characteristics are grouped together to eliminate idiosyncratic risks. Index inclusion rules should be liberal. The idea here is to hold the entire market.”

Rawson explains that the exposure should provide a type of “set and forget” mentality where they will provide stable returns over time. [Investing with ETFs: What You Should Know]

“Whereas active portfolio managers may ‘drift’ as they feel conditions warrant, a good “core” index fund, by definition, does not stray from its stated objective,” Rawson added. “Perhaps most importantly, the costs of a solid ‘core’ portfolio should be extremely low.”

Recently, iShares launched a suite of “Core” ETFs that try to provide the necessary core investment exposures, including U.S. stocks, international stocks and taxable bonds. Micro-caps are excluded, but the asset class makes up around 2% of the equity market. Bond funds exclude Treasury Inflation-Protected Securities, high-yield and international bonds as the funds reflect the construction of the widely viewed Barclays Aggregate Bond index.

Additionally, the iShares Core ETFs provide annual expense ratios of 0.07% to 0.18%.

The iShares Core ETFs include:

• iShares Core S&P 500 ETF (IVV)

• iShares Core S&P Mid-Cap ETF (IJH)

• iShares Core S&P Small-Cap ETF (IJR)

• iShares Core S&P Total U.S. Stock Market ETF (ITOT)

• iShares Core MSCI Emerging Markets ETF (IEMG)

• iShares Core MSCI EAFE ETF (IEFA)

• iShares Core MSCI Total International Stock ETF (IXUS)

• iShares Core Total U.S. Bond Market ETF (AGG)

• iShares Core Long-Term U.S. Bond ETF (NYSEArca:ITLB)

• iShares Core Short-Term U.S. Bond ETF (ISTB)

Rawson believes that a diversified core portfolio of ETFs only requires three out of the 10 holdings: ITOT at 30%, IXUS 30% and AGG 40%. This would create a basic 60/40 stocks/bonds investment portfolio with a weighted average expense ratio of 0.10%. Historically, the hypothetical portfolio of ITOT, IXUS and AGG would have returned 6.5% per year over the last 15 years.

For more information on ETFs, visit our ETF 101 category.

Max Chen contributed to this article.

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.