Seven ETFs for This Market

Many of the exchange-traded funds and exchange-traded notes being marketed these days make about as much sense for your finances as an all-nighter at the craps tables in Atlantic City. For example, DB Commodity Double Short ETN promises to give you twice the inverse of the daily moves in prices of a commodity index. Bullish on cocoa? Look to iPath DJ AIG Cocoa TR Sub-Index ETN.

The proliferation of silly products like these threatens to obscure the good news about ETFs -- that they offer you a low-cost way to invest in major market indexes. If you stick to inexpensive, broad-based ETFs, you will get a sensible alternative to index mutual funds. Inexpensive generally means annual expense ratios of 0.20% or less. You have to pay brokerage commissions to buy ETFs, so don't use them if you're investing small amounts on a regular basis.

Here's how I'd allocate my money among ETFs in today's market. For your bond money, use Vanguard Total Bond Market (symbol BND) if you're investing in a tax-deferred account or are in a low income-tax bracket. Expenses are only 0.11%.

Subscribe to Kiplinger’s Personal Finance

Be a smarter, better informed investor.

Save up to 74%

Sign up for Kiplinger’s Free E-Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

Sign up

Otherwise, stick to a mutual fund, Vanguard Intermediate Term Tax Exempt (VWITX), which totes an expense ratio of just 0.15%. I'm not sold yet on muni ETFs because many munis are thinly traded.

Start by putting 40% of your stock money in Vanguard Total Stock Market (VTI). Its expense ratio is a mere 0.07%. It tracks the MSCI U.S. Broad Market Index, which covers essentially the entire U.S. stock market. Larger companies predominate, as they do in most broad-based stock market indexes.

Stocks of large companies are cheap relative to small companies. That's unlikely to continue. Indeed, large-company stocks have been declining less than small-company stocks over the past 12 months -- although the stocks of small companies did better than those of large companies in the first half of this year. Prior to last year, small-company stocks had beaten large-company stocks in seven of the previous eight years. Consequently, small-company stocks actually trade at higher price-earnings ratios than large-company stocks. Now that large-company stocks are in ascendance again, they'll likely keep besting small-company stocks for several years.

Next invest 20% in Vanguard Mega Cap 300 Growth Index (MGK). This fund invests in the largest growth stocks in the country. The median market value of its stocks (share price times number of shares outstanding) is $46.3 billion. Fully one-third of assets is in fast-growing tech stocks, yet the average P/E of the stocks in the fund is a thrifty 19 based on earnings over the past 12 months. Its expense ratio is 0.13%

When large-company stocks do well, mega caps (the largest of the large) often do the best of all. What's more, growth stocks, like large-company stocks, have been out of favor ever since the tech bubble collapsed in 2000-2002. Many large tech stocks, as well as other fast-growing large companies, sell at modest prices relative to their earnings and other measures.

Put 15% in Vanguard FTSE All-World ex-U.S. (VEU). Don't worry about the big mouthful of a name. This ETF gives you the world's stock markets -- except the U.S. It has an expense ratio of 0.25%

To raise your stake in fast-growing emerging markets, invest 10% in Vanguard Emerging Markets (VWO), which has an expense ratio of 0.25%. The future lies with emerging markets; you don't want to shortchange them.

Invest another 10% in Vanguard Extended Market (VXF). This fund invests in all U.S. stocks except large caps and has an expense ratio of just 0.08%. Just because I think large caps are the place to be in the next couple of years, doesn't mean I'm willing to invest all my money that way. Investing will make you humble -- if it hasn't already.

The final 5% goes into ishares MSCI EAFE Growth Index (EFG). An expense ratio of 0.40% makes this the priciest ETF in the portfolio. But it gives you valuable exposure to fast-growing, large companies based outside the U.S.

When you look at the overall portfolio, 73% is in large-company stocks, 18% in midsize-company stocks and 9% in small-company stocks, according to Morningstar. Thirty-eight percent is in growth stocks compared with just 27% in value stocks. Fully 29% of the stocks are overseas, including 10% in emerging markets. I think that's much-needed international diversification.

Because growth stocks and emerging markets stocks tend to be riskier than other stocks, the portfolio is 13% more volatile than Standard & Poor's 500-stock index.

The blended expense ratio of the portfolio is a miniscule 0.14%. It would be harder to invest at lower cost.

This is hardly a buy-and-forget portfolio. Over the long haul, small-company stocks and so-called undervalued stocks have tended to beat large-company stocks and growth stocks. So some adjustments will inevitably be necessary, although perhaps not for a couple of years.

Steven T. Goldberg (bio) is an investment adviser and freelance writer.