Goldberg's Picks: The 7 Best Exchange-Traded Funds for 2013

In these uncertain times, you can still buy high-quality blue-chip stocks at discounted prices. So when investing in exchange-traded funds in 2013, make funds that invest in such companies the biggest part of your stock portfolio. But don't ignore fast-growing emerging-markets companies; many of them are also cheap.

1. Start with Vanguard Mega Cap 300 Growth ETF (symbol MGK). It seeks to replicate the faster-growing half of the MSCI US Large Cap 300 index. Over the past three years, the ETF returned an annualized 12.6% -- an average of one percentage point per year better than Standard & Poor's 500-stock index. (All returns in this article are through December 17.) And the ETF charges just 0.12% annually for expenses.

In recent years, for inexplicable reasons, stocks of faster-growing large companies haven't commanded anywhere near the premium price-earnings ratios that they normally do compared with their value-stock brethren. The stocks in this ETF trade at an average of 16 times estimated 2013 earnings, compared with a price-earnings ratio of 13 for the S&P 500. The gap is usually much wider. Perhaps investors are shunning large growth stocks because of the shellacking they took in the 2000-02 bear market. But before that selloff, large growth stocks traded at obscenely high P/Es. That is certainly not the case today.

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Apple (AAPL), the ETF's biggest holding, at about 11% of assets, is a case in point. As a result of its recent retreat, the stock sells for just 10 times analysts' estimated earnings for the fiscal year that ends in September. Overall, one-third of the ETF's assets are in tech stocks.

2. Next add Vanguard Dividend Appreciation ETF (VIG), which costs only 0.13% annually. Don't buy this ETF for its yield: a modest 2.3%. Buy it for the high-quality stocks it owns. It invests only in companies that have raised their dividends in each of the past ten years. It also insists on companies with strong balance sheets. More than one-fourth of its holdings are low-risk consumer-staples companies, such as Wal-Mart Stores (WMT), its largest holding. This ETF is so good that Warren Buffett's Berkshire Hathaway (BRK.B) recently bought more than 5% of its shares. Over the past five years, the ETF returned an annualized 4.0% -- an average of two percentage points per year more than the S&P 500.

3. Market Vectors Morningstar Wide Moat ETF (MOAT) owns the picks of Morningstar's 100-plus stock analysts with the strongest barriers against competitors. Hence the name. Morningstar is far better known for its fund research, but it actually has three times as many stock analysts as fund analysts.

The ETF is new, but a nearly identical exchange-traded note (which we wouldn't buy for reasons having nothing to do with the quality of the stock picks) returned an annualized 10.2% over the past five years. That put it in the top 1% of large-company blend funds.

4. For emerging markets, Vanguard MSCI Emerging Markets ETF (VWO) is my choice. Its holdings trade at just 11.6 times estimated 2013 earnings, despite investing in companies based in some of the world's fastest-growing economies. The ETF was launched in 2005, but over the past ten years, a regular Vanguard fund that is a clone of the ETF returned an annualized 15.6%, crushing foreign developed-markets indexes. Just remember that the ride on emerging-markets stocks is often bumpy. In 2011, for instance, the Vanguard ETF plunged 18.8%. Its expense ratio is 0.20%.

5. You can't build a diversified portfolio and ignore the developed world outside the U.S. So put some money in Vanguard MSCI EAFE ETF (VEA), which charges just 0.12% annually. After all, one day the euro zone might actually solve its problems. Japan might, too, for that matter. Besides, the market has discounted these stocks. The ETF's stocks on average trade at just 11 times estimated 2013 earnings. The S&P 500, by contrast, sells for 13 times estimated 2013 profits.

6. For investing in bonds, I prefer regular mutual funds (see my best bond fund picks for 2013) over ETFs. But if you'd rather use an ETF, choose Vanguard Intermediate-Term Corporate Bond ETF (VCIT). It offers a good portfolio of single-A bonds for just 0.14% annually and yields 2.5%. Should interest rates on similar bonds rise by one percentage point, this ETF should lose about 6% in price. But you'd still get the interest -- in fact, the yield would rise.

7. For tax-free bonds, consider iShares S&P National AMT-Free Municipal Bond (MUB). The yield is a meager 1.5%, equivalent to 2.2% for a taxpayer in the 35% bracket. The average credit quality for its bonds is single-A. This ETF will also likely lose about 6% if interest rates rise one percentage point.

Steven T. Goldberg is an investment adviser in the Washington, D.C. area. He and clients own shares of Apple and Berkshire.

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