[Editor’s Note: As the busy season hits the Karmê Chöling meditation center, Samantha Solomon is lessening the frequency of her Young and Prudent column. She’ll be back next week, but today, we’re handing it over to Special Correspondent Carl Delfeld as he discusses the use of mutual funds and ETFs in your portfolio.]
Last week, as part of describing four principles to follow when managing your portfolio, I outlined how to organize your global investments.
First, set up a core portfolio for the money you want to protect and use to produce income – with growth as a secondary goal.
Second, put together an explore portfolio with the clear objective of capital appreciation.
You’ll essentially leave the core portfolio alone, only making occasional changes, while the explore portfolio is more actively managed.
Today, I want to discuss which investment tools you should use in each of these portfolios.
The Right Tool for the Job
You have three basic choices when setting up a portfolio: mutual funds, exchange-traded funds (ETFs), and individual stocks.
Essentially, ETFs are nothing more than index funds that trade like stocks. Because of their simplicity, flexibility, low cost, and tax advantages over mutual funds, ETFs are quickly growing in popularity. Mutual funds still have the most assets by a large margin, however.
Another way to look at an ETF is as a basket of stocks or bonds that closely tracks an index or strategy. The stocks or bonds in the ETF basket usually don’t change very much.
Over the last couple of years, actively managed ETFs have become all the rage. The difference between an actively managed ETF and a typical mutual fund is packaging and fees and taxes.
For your core portfolio, in which you’ll follow more of a buy and hold strategy, while having some low-cost mutual funds is fine, using lower-cost ETFs can help maximize after-tax returns.
Your core portfolio should be well-diversified, with about 20% allocated to each of these five areas: U.S. stocks, foreign stocks, bonds, real estate – through real estate investment trusts (REITs) – and commodities.
One strategy is to have plenty of exposure to dividend-rich ETFs in your core portfolio.
One of my long-term favorites is the iShares Global 100 ETF (IOO), which is a basket of the largest 100 companies in the world. It offers a current dividend yield of 2.9%.
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Perhaps an even better option is the Global X SuperDividend ETF (SDIV), which tracks the performance of 100 equally weighted companies that rank among the highest dividend-yielding equity securities in the world. The dividend yield for this ETF is an impressive 6.99%.
SDIV also offers a good amount of diversification with exposure to REITs (42%), consumer discretionary stocks (4%), telecommunications (16%), financial services (14%), utilities (7%), banks (5%), consumer staples (5%), energy (5%), industrials (9%), and healthcare (2%).
About 32% of the companies in the basket are based in the U.S., 24% in Australia, 10% in Great Britain, 6% in Canada, and 4% in Singapore, among others.
Another powerful ETF you could blend into your portfolio is the PowerShares International Dividend Achievers Portfolio (PID), which offers a dividend yield of 3.66%.
To be included in this exclusive basket, companies need a record of increasing dividends for five consecutive years. The United Kingdom and Canada make up 55% of its holdings, with the U.S. at only 7%.
The Dividend Achievers Portfolio is up 7.9% so far in 2016, and its basket of stocks trades at just 12 times 2016 expected earnings. It’s a stock I would buy today without any hesitation.
That takes care of the use of ETFs in your core portfolio. Now, for your explore portfolio, I would suggest placing this more active portfolio within an IRA or 401(k) account to avoid paying capital gains taxes each year.
In addition, I would avoid mutual funds for your explore portfolio if possible – many funds have penalties if you sell them within six months or so.
ETFs and stock picking are ideal for this type of portfolio. Just make sure you do your homework and have a clearly defined strategy.
It’s also smart to have trailing stop losses in place to lock in gains and minimize losses. And don’t be too aggressive – even the explore portfolio should be well-diversified.
Build your core, manage your explore portfolio, manage your risk, and lean towards ETFs. Your performance will improve, and you’ll even sleep better at night.