5 Best iShares ETFs: A Core Portfolio For Fidelity Brokerage Clients - Part 2

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Includes: AGG, IEFA, IEMG, IXUS
by: ETF Monkey
Summary

Whether you are already a Fidelity Brokerage client, or just starting your journey in the world of investing, this two-part article is for you.

In Part 1 of the series, I featured the benefits of Fidelity and the 70 iShares ETFs you can trade commission-free.

I also recommended 2 specific ETFs for the Domestic Stocks portion of the portfolio.

In Part 2, I recommend ETFs for Foreign Stocks and Bonds, offer some suggested asset weightings by age group, and further reading on the topic of rebalancing.

In Part 1 of this two-part series, I provided an introduction to the portfolio and featured its merits for a wide variety of investors. I then offered 5 suggestions for further reading for those new to either ETFs or basic concepts for building a portfolio. Next, I discussed the benefits of Fidelity as a solid brokerage choice, specifically related to the 70 iShares ETFs for which they offer commission-free trading. Finally, I offered fairly detailed reviews of two specific ETFs for the Domestic Stocks portion of the allocation.

In Part 2, I will add ETFs for the portion of the portfolio dedicated to Foreign Stock and Bonds. I will also offer some suggested weightings across various age groups as well as some optional further reading on the concept of rebalancing your portfolio.

Foreign Stocks

It is my view that every investor should include at least some weighting in foreign stocks in their portfolio. Principally, this is because they offer the benefits of diversification as well as potentially greater growth. In this article, I provide more detail for those who are interested.

Before we go any further, I think it worthwhile to briefly discuss the two broad classes in which foreign stocks are generally classified; those from developed markets and those from emerging markets.

In general, a country is considered developed if it has a highly-developed capital market, competent and serious regulatory agencies, and high levels of per-capita income.

Emerging economies, on the other hand, tend to be characterized by higher levels of economic, political, or social instability, lower per-capita income, and still-developing infrastructure.

An easy way to get exposure to both is to select a Total International Stock ETF. As it happens, the iShares Core MCSI Total International Stock ETF (IXUS) from iShares would fit the bill. Trading commission-free at Fidelity, this ETF offers all-in-one exposure to both developed and emerging markets, with an extremely reasonable .11% expense ratio.

In the table featured in Part 1 of this article, however, you will notice that this is not the ETF I selected. Instead, I selected two ETFs; the iShares Core MCSI EAFE ETF (IEFA) and the iShares Core MCSI Emerging Markets ETF (IEMG). Why did I elect to go this route? For two reasons:

  1. As opposed to accepting the default allocation between developed and emerging markets found in IXUS, using two ETFs allows each investor to select their desired allocation. Some investors, for example, may not wish to invest in emerging markets whereas others may want to aggressively expose themselves to this exciting segment of the markets.
  2. IEFA carries an extremely low expense ratio of .08% whereas IEMG carries a slightly higher expense ratio of .14%, reflecting the higher trading costs involved in investing in emerging markets. While this is not a huge deal, the investor who wishes to focus more on developed markets may be able to achieve a lower overall expense ratio.

Let's start by taking a closer look at IEFA. IEFA tracks the MCSI EAFE IMI Index, and invests in 2,516 stocks. With respect to income, it carries a 30-Day SEC Yield of 2.48%. And, as mentioned previously, all of this for a rock-bottom expense ratio of .08%!

Here is a graphic of the fund's largest country exposures.

Source: IEFA Information Page

As can be easily seen, the fund's single largest exposure is to Japan, at 25.29% of the fund. Moving on from there, the United Kingdom and the European countries displayed in the list cumulatively total to an additional 58.40%. Add in Hong Kong and Australia and you've accounted for almost 93% of the fund.

Here are the Top-10 holdings of the fund.

Source: IEFA Information Page

Clearly, this list comprises some of the most impressive companies to be found outside of the U.S.; including the biggest food company in the world, two world-class pharmaceutical companies and a couple of premier oil & gas companies. Pondering that list for just a couple of minutes should convince you of the diversification benefits of allocating a percentage of your investments beyond the borders of the U.S.

Let's move on now to IEMG. IEMG tracks the MCSI Emerging Markets Investable Market Index, and invests in 1,923 stocks. With respect to income, it carries a 30-Day SEC Yield of 1.85%, and has an expense ratio of .14%.

Here is a graphic of the fund's largest country exposures.

Source: IEMG Information Page

Again, likely it becomes immediately obvious that whereas IEFA is heavily weighted towards Europe and the UK, an investment in IEMG is to a large extent an investment in Asia, with China far and away its single largest country exposure.

Here are the Top-10 holdings of the fund.

Source: IEMG Information Page

In combination, then, IEFA and IEMG offer exposure to over 4,400 stocks, covering almost every corner of the globe.

Before we leave this section, let me repeat that concept of flexibility. You are free to fill the foreign allocation of your portfolio with any combination of IEFA and/or IEMG that you choose. In general, emerging markets offer the greatest risk, but also the greatest potential for growth. You can avoid emerging markets altogether, "dip your toe" into them, or invest in them heavily. The choice is yours.

Bonds

This brings us to the last asset class in the portfolio. Bonds.

In some ways, the word "bonds" is almost a dirty word in the current environment. After a lengthy bull market in bonds (an extended period of either flat or declining interest rates), the threat of inflation has once again entered the discussion. Certainly, there are factors that give rise to valid concerns. Particularly after the financial crisis of 2008-2009, central banks all over the world have pumped liquidity into the system by actively buying assets. A recent note from Goldman Sachs posited that increasing U.S. government debt poses fiscal dangers.

On the other side of the coin, have a look at this graphic from Vanguard. It features the best, worst, and average returns for various stock/bond allocations across the years from 1926-2013.

Source: Vanguard PDF

As just one example, from the above it can be seen that even a rather modest 20% allocation to bonds only dropped average overall returns from 10.2% to 9.6% as compared to an allocation of 100% stocks, while reducing the largest drawdown to 34.9% from 43.1%. In other words, over the span of 87 years, you reduced the "worst case" decline by over 8%. Why might this matter? Because none of us can predict every occurrence in our lives. One never knows when one might need to raise cash to meet some unexpected financial need. It is for this reason that we seek to balance risk in our portfolio. Clearly, bonds have historically helped to do this.

My ETF selection for this portion of the portfolio is the iShares Core U.S. Aggregate Bond ETF (AGG).

Source: AGG Information Page

In addition to this breakdown, in the fact sheet iShares provides for AGG, they offer a nice additional graphic with further detail on characteristics of the fund.

Source: AGG Fact Sheet

As can be seen from the above, some 86.2% of the bonds in AGG carry a credit rating of A or above, with 71.91% being AAA rated. Another key number to look at is the effective duration number of 5.77 years shown in the lower left-hand corner. Essentially, what this means is that a 1% increase in interest rates would be expected to reduce the price of AGG by roughly 5.77%. Currently, AGG offers a 30-Day SEC Yield of 2.74%.

As one last thought in this section, if you would like to check out a bond offering with a little less price risk, check out this article. It features a Vanguard ETF with a duration of only 2.7 years. Currently, that fund yields approximately 1.75%. A little less income, but with a little less risk. Also, this ETF is not included in Fidelity's commission-free offerings, so you'll have to pony up $4.95 per trade. Don't ever say that ETF Monkey doesn't give you options!

Suggested Asset Weightings

So now we have the 5 ETFs with which to build the portfolio. The next big question is: "Yeah, but how much of each should I buy?"

Before you look at the chart below, let me reiterate one thing. These are merely very high-level suggestions. There are so many factors that come into play (personal circumstances, health, personal risk tolerance) that it is impossible to present a single "perfect" allocation.

Age

25

(Retire 2060)

40

(Retire 2045)

55

(Retire 2030)

65

(Retire 2020)

iShares ITOT

44.00%

42.00%

30.00%

20.00%

iShares HDV

10.00%

12.00%

13.00%

14.00%

iShares IEFA

21.00%

23.00%

19.00%

16.00%

iShares IEMG

15.00%

13.00%

9.00%

6.00%

iShares AGG

10.00%

10.00%

29.00%

44.00%

TOTAL

100.00% 100.00% 100.00% 100.00%

At the same time, it can be helpful to at least have some idea of what to use as a starting point. The above suggested weightings were developed by examining the weightings used by target-date retirement funds offered by a major provider, fine-tuned to include all 5 ETFs included in my suggested portfolio.

With respect to the above table, let me offer just two observations.

  1. If you look closely, you may notice that the basic allocations to Domestic Stocks, Foreign Stocks and Bonds are, in total, the same for the 25-year-old and the 40-year-old. Per the target-date resource I used, this is correct. However, you will notice I made the allocation slightly more conservative for the 40-year-old by slightly shifting a little more into both HDV and IEFA.
  2. You might notice that I have a suggested weighting of 6% in emerging markets even for the 65-year-old. Wait a second! Up above, I featured that emerging markets carry with them a measure of risk! What am I, crazy? Here's the deal. While we are certainly thinking of getting a little conservative at that age, the simple fact is that many healthy individuals are living deep into their 80s and in some cases even their 90s! That is a wonderful thing! From an investment standpoint, however, this argues that we want to to think about keeping at least a little potential for growth in the portfolio. Again, ultimately you have to decide what you feel comfortable with. But there's some food for thought.

Rebalancing

Over time, as markets ebb and flow, various asset classes in the portfolio will either outperform or underperform. For example, foreign stocks may rise for some period of time while U.S. stocks stagnate. This will cause the portfolio to diverge from your intended weightings.

In this article, I take a deep dive into the topic of rebalancing. Feel free to refer to this as a resource as the need arises.

Summary and Conclusion

In this two-part series, I have suggested 5 specific ETFs to help you build an extremely low-cost, yet well diversified portfolio. If you look back at the table I provided in Part 1, it will become readily apparent that, no matter how you ultimately decide to allocate between the 5 ETFs, you are going to have an overall expense ratio in the .05% - .08% range. Further, if you use Fidelity as your brokerage of choice, you can trade all of these ETFs commission-free. Particularly for that younger investor, who may wish to make regular monthly contributions, that one factor alone will make a huge difference!

If you decide to investigate my writings here on Seeking Alpha, you will find that I have built somewhat similar portfolios featuring ETFs from Vanguard and Charles Schwab. I even featured a portfolio specifically designed for Millennials and using TD Ameritrade as my broker of choice.

You see, at the end of the day, you have many options. The main thing is to get started!

If you have a great story to share, I'd love to hear it in the comments section!

Until next time, then, I wish you . . .

Happy investing!

Disclosure: I am/we are long AGG, HDV, IEFA, ITOT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am not a registered investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes, and to consult with their personal tax or financial advisors as to its applicability to their circumstances. Investing involves risk, including the loss of principal.