Building a basic portfolio using ETFs (2024)

Not quite ready to do all your own stock picking? Maybe you’re a novice investor who wants some broad exposure to stocks as you learn more about the stock market. Or maybe you’ve already chosen a few stocks but you’re not confident you have enough variety for a well-diversified portfolio. In either situation, you might look at exchange traded funds (ETFs) as a step to creating or rounding out that basic portfolio.

Let’s dive into some basic ETF strategies and consider different ETFs that are available to suit various investing goals. This article lays out some basics for both novice investors and those with more experience who might want to use ETFs as another tool in their investment toolbox.

When it comes to building an ETF portfolio, or any kind of portfolio, one of the first big portfolio decisions is what percentage of your money you’ll commit to stocks and what percent to bonds — this is the asset mix between stock and bonds. Stocks and bonds each play their own role in your portfolio — how much to allocate to each one depends mainly on your risk tolerance, time horizon and investment goals. While you might also decide to keep some of your assets in cash, this article will discuss the portion of your portfolio that’s focused on stocks and fixed income.

Stocks, also known as equities, represent partial ownership of a company and may have the potential for capital appreciation and long-term growth. They can act as a hedge against inflation and may provide dividend income, but they can be volatile. Bonds, also known as fixed income investments, are used to reduce overall risk and provide stability during market downturns. They have the potential to preserve capital and generate consistent income.

Generally, younger investors can consider investing more in stocks. These investors typically have a longer time horizon ahead of them before they’ll withdraw and spend this money, especially if it’s money earmarked for retirement. This is an advantage with stocks, as stocks’ price volatility typically smooths out over longer periods. However, for any age group, when specific funds are tagged for shorter-term purchases — think vacation or even buying a house, if that’s in the near future — the amount of acceptable risk usually drops. The portfolio makeup has to reflect that reality and that usually means a smaller allocation to equities and more to fixed income.

You probably also want to take your psychological risk tolerance into account. Some investors can tolerate more portfolio volatility than others, regardless of when they plan to use the money they’ve invested. In this respect, you have to know yourself and build that knowledge into your planning. This helps avoid jumping out of potentially lucrative investments when those investments inevitably fluctuate in price.

For longer discussions on these topics if these concepts sound unfamiliar, check out our Investing 101 course.

An index ETF tracks the performance of a specific market benchmark or index as closely as possible. To accomplish this, the fund's manager buys all (or a representative sample) of the stocks or bonds in the index it’s tracking and then updates and maintains the Index ETF over time. Some index funds may also use derivatives, such as options or futures, to help achieve their investment objective.

Since the makeup of most indexes changes from time-to-time, the fund manager of the Index ETF will monitor the changes and update the ETF when necessary. There are two common reasons for index changes. The first is to reflect corporate events, like takeovers or bankruptcies, that might mean a company is no longer public or no longer trading. The second is to adjust the index composition so companies that best reflect the current economy remain, and less relevant companies are replaced.

Index ETFs offer a way to invest in a broad range of companies and track the market without needing to be an expert in picking many individual investments. These ETFs are typically offered at a relatively low cost because they don’t require active stock picking. Because they provide instant diversification along with low fees, they offer the convenience of a one-stop-shop to begin portfolio building.

There are 2 paths to consider:

1. Select an Asset Allocation ETF, also known as a Balanced ETF, which has allocations to stocks and bonds in a single ETF. There are many Asset Allocation ETFs available, so it’s relatively simple to find one with asset mix percentages that match or approximate your chosen target asset mix. This option may require less research but may not exactly match your asset mix preferences. If you’d like to further fine-tune, consider Option 2.
2. Choose individual ETFs for each asset class you want to include and, based on your target asset mix, invest the calculated percent in each ETF type. This lets you hit the target asset mix percentage more precisely.

Be sure to use Investor’s Edge ETF screener, which lets you pick your criteria and easily filter through hundreds of ETFs to find choices that meet your specifications.

If you invest in an Asset Allocation ETF rather than choosing Index ETFs yourself, the ETF fund manager will monitor the asset mix and periodically rebalance the fund to maintain the stated asset mix percentages. If your circ*mstances change and you feel a different asset mix is more appropriate for you, the solution is quite straightforward. You’ll sell your current Asset Allocation ETF and buy another that reflects the new asset mix percentage.

Typically, the fees for Asset Allocation ETFs are higher than a similar blended portfolio of Index ETFs that you select. Some investors find the convenience of having a manager rebalance the portfolio worth the higher fees — this is a choice you’ll have to make yourself.

As mentioned, with individual ETFs there will come a point where you’ll have to sell some holdings to decrease their size in the portfolio and buy others to maintain your target asset percentage mix. It makes sense to consider rebalancing regularly, perhaps monthly or annually, or when the portfolio strays from a target mix percentage by a certain predetermined amount, perhaps 7 to 10%.

Rebalancing will mean selling some of the “winning” assets and buying more of the “losing” assets. Some investors may find it psychologically difficult to sell some of their best performers and buy more of the laggards to get back to 60/40, but it’s a necessary step to maintain your target asset mix percentage. This strategy also allows you to potentially lower your cost basis, as you’re generally buying some of the lagging asset group at a lower average price and selling some of the outperforming group at a higher average price.

Once you’ve created a basic ETF portfolio, there are other ETFs available that can address more specific investor needs or interests. Some of these will give you specific exposure to subsets of an asset class. For example, there are fixed income ETFs that target emerging market debt, U.S. investment grade corporate debt or even Canadian floating rate notes. Other ETFs address particular interests or investing segments; ESG-focused ETFs are one currently popular example. There are also a wide range of ETFs that focus on industry groups — gold stocks, financial stocks and many others — or specific country ETFs.

We’ll consider these options in more detail in Fine-tuning your portfolio using ETFs.