Best ETFs for Your Investment Portfolios

Fund managers wage war against the markets every day, trying to pick stocks or bonds that will push them past their benchmark bogeys. More often than not, the markets win. But investors don’t have to lose out, too. They can choose to invest in exchange-traded funds instead. Broad ETFs can capture nearly all of a market’s returns by passively tracking a benchmark, such as Standard & Poor’s 500-stock index.

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Expense ratios are so low you may pay as little as 0.03% a year—just 30 cents for every $1,000 invested—for an ETF that mirrors the stock market.

Yet with more than 2,000 ETFs now on offer, picking a few good ones can be daunting. More than a dozen funds track versions of the S&P 500 alone. Plus, scores of ETFs aim to beat the markets by carving out certain types of stocks or bonds, or by emphasizing things such as share-price momentum—anything to give them an edge over traditional indexes.

Some of these “smart beta” ETFs offer advantages. But many are likely to disappoint in the long run. Expense ratios tend to be steep, eating into returns. Moreover, free lunches don’t last long. If one exists, investors will quickly find it, bid up the mispriced securities and gobble up “excess returns” before holders of these enhanced ETFs can benefit. Rob Arnott, head of investment-services firm Research Affiliates and one of the fathers of smart-beta investing, warned in February that many smart-beta ETFs may “crash” because they’ve become too popular, with prices of their under­lying securities so inflated that they’re unlikely to deliver market-beating returns.

Whatever your goals, the portfolios below can serve as the bedrock of your investment program for years. Three of them hold ETFs you can buy without trading commissions at either Fidelity, Schwab or Vanguard. The fourth, an income portfolio, isn’t geared toward any particular broker, so you’ll likely have to pay commissions to buy at least some of the ETFs it contains.

Each basket features a broad mix of common stocks and bonds, including several funds in the Kiplinger ETF 20. Our income portfolio also holds less-traditional asset categories, such as master limited partnerships.

If you want maximum gains, go for our growth portfolio, which mainly uses Schwab-run ETFs. The funds in this basket feature the highest mix of stocks (80%) compared with bonds (20%). U.S. stocks have returned about 10% a year, on average, since 1926, including dividends. That trounces the long-term returns of bonds. But it’s unusual for stocks to deliver the average return in any given year, and they have shown they can lose more than one-third of their value in short order. Buy this portfolio only if you won’t sell in a panic during a market downturn, and aim to hold it for at least a decade.

Fewer stocks, more yield.

If you’re more risk-averse or plan to start withdrawing money in less than 10 years, choose our moderate or conservative portfolio. These baskets of ETFs hold considerably less in stocks than the growth portfolio, making them more stable. Our moderate-risk package features a lower stake in stocks (60%). It generates a decent yield (2.2%), thanks to ETFs that hold real estate investment trusts and corporate bonds. Fidelity customers can assemble this portfolio without paying brokerage fees.

In our conservative package, ETFs holding high-quality corporate and government bonds make up the largest slice of the pie (60%). With bond yields near record lows—and at negative levels in Europe and Japan—these ETFs don’t pay much. But they help push the portfolio’s income to about 2.5%, which isn’t bad in a low-yield world. Moreover, high-quality bonds can be a bulwark against losses in stocks. This portfolio relies on Vanguard-sponsored ETFs, which don’t cost a penny to trade if you’re a Vanguard brokerage customer.

For income investors, we recommend a mix of traditional bonds, preferred stocks and other income investments, aiming for a 5% yield. The portfolio may lose money, especially if interest rates rise or if the yield investments, such as real estate investment trusts and master limited partnerships, take a hit. But lower bond prices would push up yields, delivering more income over time. And some of the portfolio’s yield investments, such as MLPs, may move up even as bond prices decline. Depending on which broker you use, you will have to pay commissions to trade some, if not all, of the ETFs in this portfolio.

One note: Most of the ETFs in this basket shell out income that is taxed at ordinary income tax rates. Your returns may be much higher if you can hold the portfolio in an IRA or other tax-sheltered account.

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