Instead of compiling market segments and sectors into a comprehensive equities portfolio, investors should utilize broad index-based exchange traded fund as an efficient way to capture broad market exposure.
“For taxable accounts, a broad index fund is a better option for investors building a complete allocation to U.S. equities compared with using separate size segment funds,” according to Morningstar analyst Michale Rawson. “Because a broad fund holds both large- and small-cap stocks, it is not forced to buy or sell as stocks migrate into a different market-cap range.”
Through a total market ETF, investors can gain access to thousands of stocks across various market segments and categories. For instance, the Vanguard Total World Stock ETF (NYSEArca: VT), iShares Russell 3000 ETF (NYSEArca: IWV), Schwab U.S. Broad Market ETF (NYSEArca: SCHB) and SPDR Russell 3000 ETF (NYSEArca: THRK) all provide broad stock exposure across all market capitalizations.
VT covers 6,550 stock components and comes with a 0.18% expense ratio. IWV tracks 3,024 stocks and has a 0.20% expense ratio. SCHB includes 2,026 holdings and has a 0.04% expense ratio. THRK follows 2,520 components and has a 0.10% expense ratio. [Build a Dirt-Cheap Portfolio With These ETFs]
Rawson points out that these broad index funds are an efficient way to access the markets. Specifically, if a small-capitalization stock were to appreciates in price, a small-cap-specific fund would have to sell it while a large-cap-specific fund would have to purchase the stock. However, the same stock would just fluctuate up or down in size but stay in the same broad index fund.
“Market-cap-weighted equity index funds tend to be more tax-efficient than active strategies because they tend to have low turnover,” Rawson added. “ETFs have an additional advantage over mutual funds that stems from their ability to rid themselves of low-cost-basis shares through the in-kind redemption mechanism.” [In-Kind Creations and Redemptions]
Nevertheless, asset class category-specific funds still have a place in some investment portfolios. Investors who prefer overweighting specific market capitalizations can also include small-, mid- and large-cap stock ETFs. For instance, the iShares Russell 2000 ETF (NYSEArca: IWM), iShares Core S&P Mid-Cap ETF (NYSEArca: IJH) and SPDR S&P 500 ETF (NYSEArca: SPY) are the largest small-, mid- and large-cap ETFs, respectively.
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.