Building an ETF Portfolio

An ETF consists of a collection of stocks or other securities that usually track an index (see What is an ETF?). Thus, each ETF is approximately as diversified as the index that it tracks. Since each index represents some defined sector of the investment world, constructing a portfolio requires that you decide what parts of the market you want to invest in. Making these choices can be easy or hard depending on your investment goals.

If your goal is to purchase a large cross section of the US stock market, there are 4 ETFs (VTI, IWV, TMW, and SCHB) that each track an index that represents most of the US stock market. Each index is slightly different so the performance of these ETFs is slightly different from each other. If you click here, you can see a "perfchart" graph from stockcharts.com that shows the performance of VTI, IWV and TMW, all of which have been in existence for over 10 years. The perfchart (short for "performance chart") shows the total performance of each ETF, i.e., reinvestment of the dividends and other distributions is assumed on the day following the distribution pay date. The default view is for 200 market days, i.e., 40 weeks. A slider in the bottom right hand corner of the graph lets you view an arbitrary period back to the time of the most recently created ETF. SCHB is a more recently created ETF, so when you click on this sentence you will see a graph comparing all 4 of these ETFs. Again move the slicer to see the entire history back to the creation of SCHB.

Which of these 4 ETFs should you buy? One way to choose is which one is cheaper to own. What does this mean? Not surprisingly, each ETF charges an annual fee to take care of your money. The annual fee is "magically" included in the price of the fund and the distributions it give, so it is essentially transparent to the owner. The size of the annual fee, however, will affect the long-term performance. If you consider the fees alone, the SCHB ETF has the lowest charges, and if you buy it through an account at Schwab, there is no commission fee to either buy or sell the ETF. If you are an ordinary investor, no commissions can be a big saving. For example, the standard commission at Schwab is 8.95. If you buy a $1,000 worth of shares, you pay an additional $8.85 which is 0.89% of the total. For a buy and sell, this amounts to 1.78%. This adds up over time. The impact is, of course, much worse if you make big purchases and sales, but if the commission is zero the savings are clear. Other brokers also have no commission ETF's so shop around.