ETF Portfolios: Beyond Expense Ratios

Matt Hougan of Index Universe recently republished his "ultimate" low expense portfolio of ETFs. The reason? His buy-n-hold cluster is actually cheaper than it had been before (0.15%).

Here's Matt's list of investments:

The cost is less than 0.14%. Meanwhile the average stock mutual fund may run you upwards of 1.3%, robbing you of a full 1% of your potential wealth every year. Score points for the ETF believers.

However, investors today need to be a bit more discerning beyond expense ratio alone. (And that's from a guy who tells you that one of the most important axioms in investing is "the lower the cost, the higher the returns.")

For instance, how much would a 75% stock/25% other portfolio have cost an investor in the 2000-2002 bear market? Even a conservative estimate that gives credit to the bonds and REITs in the lazy buy-n-hold approach could easily have lost upwards of 35%-40% from top to bottom. Are people really okay with watching $500,000 become $300,000... and waiting 5 more years to see their portfolios break even?

Perhaps the most important tenet of smarter, more balanced investing is to "never suffer a big loss." That can be accomplished by developing an approach to selling; specifically, you do not have to be a day-trading fool to understand that the only real wealth killer is a bear market. So prepare to sell when necessary.

Moreover, savvier investors should recognize trends to make strategic shifts. For instance, it has become abundantly clear since the summer of 2006 that large-cap has replaced small-cap. And since that time, I have nearly eliminated my long-running small-cap star iShares Russell 2000 (IWM), while moving more heavily towards the larger iShares S&P 100 (OEF).

Granted, the Vanguard Total Market Index Fund (VTI) is market-cap weighted, and therefore, not as affected by smaller companies. Nevertheless, why ignore clear shifts from smaller companies to larger corporations in an economic slowdown? Why ignore the strength of small-caps from 2000-2005 by dropping everything into the large-cap-favored VTI?

And can all of your fixed income truly be summed up in the Total Bond Index (BND)? When the dollar is falling, and foreign treasuries may actually provide a safer haven from "high-quality" U.S. debt, perhaps foreign fixed income should have a place in this picture. I like the SPDR Lehman Intl Treasury Bond ETF (BWX).

My point is not to give Matt Hougan a difficult time... far from it! Matt is showing the world just how easy is to gain access to commodities, bonds and stocks through low-cost ETF indexing. (He did forget currencies... but we can let that slide.)

Instead, I want investors to keep in mind that they can and should make strategic shifts to their portfolio. If small-caps are a bit tired after dominating the decade, you can cut back. If foreign bonds provide a unique opportunity to capture the same safety, the same yield, and a greater opportunity for true diversification, you can buy in.