3 Ways to Build an All-ETF Portfolio

July 5, 2023 Michael Iachini
An index ETF-only portfolio can be a straightforward yet flexible investment solution.

There are plenty of advantages in using exchange-traded funds (ETFs) to fill gaps in an investment portfolio, and lots of investors mix and match ETFs with mutual funds and individual stocks and bonds in their accounts. But it's equally possible to build a complete portfolio out of nothing but ETFs, which in most cases track indexes for a variety of asset classes. In this article, we'll discuss the benefits and trade-offs to consider when building an ETF-only portfolio using index ETFs. (While actively managed ETFs do exist, in this article an all-ETF portfolio refers specifically to using index ETFs only.)

How can you tell if an all-ETF portfolio makes sense for you? For the most part, it comes down to what your goals are—and your preferences. As a general rule, ETFs provide excellent diversification at a low operating expense ratio (OER) since many are passive funds that track a certain benchmark index. Because of this, they typically offer transparency—it's easy to see what stocks, bonds, or other investments the ETF holds each day. If these are top characteristics you look for in your investments, owning nothing but ETFs may be a straightforward yet flexible solution worth a closer look.

There are some trade-offs to think through. An all-ETF portfolio means giving up actively managed mutual funds, which have the potential to outperform index ETFs through professional selection of stocks and bonds. You'll also leave behind the control that comes with a portfolio composed solely of individual securities you have selected. Some people won't want to give these things up, even though these approaches have specific disadvantages as well (see table below). You'll also need to be comfortable with the risks that come with any ETF, including market risk and liquidity risk, as well as the expenses of the ETFs.

A portfolio of index mutual funds, meanwhile, would be very similar to an all-ETF portfolio with two main exceptions: ETFs trade differently than index mutual funds, and for certain niche asset classes, you can find ETFs but very few or no index mutual funds.

Some pros and cons of four types of portfolios relative to each other

Some pros and cons of four types of portfolios relative to each other
  • Portfolio
  • Pros
  • Cons
  • Portfolio
    Actively managed mutual funds
  • Pros
    • Professional active management
    • Potential to outperform the market
    • Diversified well among various securities 
    • Largest number of fund choices 
  • Cons
    • Higher ongoing expenses 
    • Possible underperformance 
    • Least transparent 
    • Higher portfolio turnover 
  • Portfolio
    Index mutual funds
  • Pros
    • Diversified very well among various securities
    • Generally low ongoing expense 
    • Seeks to match index performance (minus fees and expenses) 
  • Cons
    • Limited selection in certain asset classes 
    • No active management 
    • No potential to beat the index 
  • Portfolio
    All-Index ETF portfolio
  • Pros
    • Diversified very well among various securities 
    • Generally low ongoing expenses 
    • Niche options available if desired 
    • Transparency on a daily basis into the makeup of the fund
    • Trading flexibility 
    • Seeks to match index performance (minus fees and expenses) 
  • Cons
    • No active management 
    • No potential to beat the index 
  • Portfolio
    Individual stocks and bonds
  • Pros
    • No ongoing management expenses 
    • Maximum control 
    • Complete transparency 
  • Cons
    • Higher transaction costs 
    • Diversification can be more difficult 
    • No professional management 
    • Certain types of bonds may have low liquidity (for individual bonds) 

If you think an all-ETF portfolio might suit you, here are three ways to build one, ranging from ultra-simple to very fine-tuned.

1. Keeping it simple

One option you can consider would be using two ETFs to help provide a balanced, diversified portfolio of stocks and bonds:

  • A total world stock market ETF
  • A total bond market ETF

For instance, if you're an investor seeking moderate risk and decide that you want 60% of your portfolio in stocks and 40% in bonds, you could consider purchasing an all-country stock index ETF and then combine it with a bond ETF.

World stock market ETFs may track an index like the Morgan Stanley Capital International All Country World IndexSM (MSCI ACWI), which provides exposure to U.S. stocks, developed-market international stocks, and emerging-market international stocks.

Some bond ETFs track the broad Bloomberg U.S. Aggregate Bond Index, which covers:

  • Treasury bonds
  • Government-agency bonds
  • Mortgage-backed bonds
  • Investment-grade corporate bonds
  • Some dollar-denominated international bonds.

The advantage of this type of portfolio is its simplicity: one stock fund and one bond fund. It will be easy to see when you need to rebalance. Plus, because ETFs trade intraday like stocks and trade with a bid/ask spread, a two-ETF portfolio can help keep your trading costs low.1

One disadvantage of this portfolio is that it's not very fine-tuned. For instance, as of December 31, 2022, MSCI ACWI IMI had about 59% in US stocks and 41% in non-US stocks, according to Morgan Stanley Capital International. If you prefer to have a larger allocation to US stocks, for example, you might want two separate stock ETFs.

Another drawback to this portfolio is that it lacks any allocation to Treasury Inflation Protected Securities (TIPS), sub-investment grade bonds (also known as high yield or junk bonds), and non-dollar-denominated international bonds, not to mention other asset classes such as commodities and real estate. Additional asset classes can help further diversify your portfolio. Still, if simplicity is what you seek, the two-ETF portfolio can be an alternative worth considering.

2. Middle of the road

An intermediate approach to an all-ETF portfolio could consist of about 8 ETFs.

For stocks, you could have:

  • A large-cap U.S. ETF
  • A small-cap U.S. ETF
  • An international developed-market ETF
  • An emerging-market ETF.

For bonds, you could start with the same core bond ETF described above and diversify further by including ETFs that invest in:

  • TIPS
  • Sub-investment grade ("high-yield" or "junk") bonds
  • International bonds.

The advantage of this portfolio is that it can help provide balance. It has enough ETFs to give you coverage of more asset classes and the ability to adjust your portfolio weights in most areas, but not so many funds that it becomes too challenging to keep track. The disadvantage of this portfolio is that it offers neither maximum simplicity nor maximum customizability.

3. Fine-tuned

On the other end of the spectrum from an ultra-simple ETF portfolio is a fine-tuned portfolio with 20 or more ETFs. This type of portfolio can make sense for investors who like to allocate their accounts toward exactly the parts of the market they expect to perform best.

This portfolio begins similarly to the middle-of-the-road ETF portfolio but then divides the various parts into thinner slices:

  • U.S. large-cap stocks can be divided into sectors such as financials and health care, or even narrower industries such as banks and biotech.
  • The U.S. stock allocation can further be divided to include mid-cap or micro-cap stocks, or styles such as growth and value.
  • The international stock allocation can be adjusted to include international small-cap stocks in regions, such as Europe and Asia or in individual countries like Germany and China.

The core bond index can be broken into its components:

  • Treasuries
  • Agency-backed bonds
  • Mortgage-backed securities
  • Corporate bonds.

The average maturity of the bonds in the portfolio can be fine-tuned to include more long-term bonds or short-term bonds.
Commodity ETFs can be added to the portfolios, and split into fine slices such as:

  • Oil
  • Gold
  • Agricultural commodities
  • Base metals

Real estate ETFs can be added to the portfolio and could even be split into U.S. and global.

With the fine-tuned portfolio, it's unlikely that you would want to hold every possible ETF at the same time. For instance, rather than holding allocations to all 11 stock sectors and every individual country possible, you would likely have core allocations to certain ETFs, and then add weight to the ETFs representing only those sectors or countries that appear most attractive.

The advantage of this portfolio is the ability to get almost exactly the exposure you want to each narrow piece of the market while still enjoying the diversification that ETFs offer over individual stocks and bonds.

The disadvantages are complexity and trading costs. With so many ETFs in the portfolio, it's important to be able to keep track of what you own at all times. You could easily lose sight of your total allocation to stocks if you hold 13 different stock ETFs instead of one or even five. In addition, with so many ETFs in the portfolio and relatively more buying and selling, the impact of bid-ask spreads could add up quickly.

1ETF shares are sold at one price (the "ask") and bought at a lower price (the "bid"). Whenever you trade, you're generally losing half of the bid/ask spread, since you either buy at the higher bid price or sell at the lower ask price.

Investors should consider carefully information contained in the prospectus or, if available, the summary prospectus, including investment objectives, risks, charges and expenses. You can request a prospectus by calling Schwab at 800-435-4000. Please read the prospectus carefully before investing.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. 

Investing involves risk including loss of principal.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. 

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Diversification, asset allocation, and rebalancing strategies do not ensure a profit and do not protect against losses in declining markets. Rebalancing may cause investors to incur transaction costs and, when rebalancing a non-retirement account, taxable events can be created that may affect your tax liability.

Some specialized exchange-traded funds can be subject to additional market risks. Investment returns will fluctuate and are subject to market volatility, so that an investor's shares, when redeemed or sold, may be worth more or less than their original cost. Shares of ETFs are bought and sold at market price, which may be higher or lower than the net asset value (NAV).

All ETFs are subject to management fees and expenses. Please see Charles Schwab Pricing Guide for additional information.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks, including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. The lower rated securities in which high yield funds invest are subject to greater credit risk, default risk and liquidity risk.

Treasury Inflation-Protected Securities (TIPS) are inflation-linked securities issued by the U.S. government whose principal value is adjusted periodically in accordance with the rise and fall in the inflation rate. Thus, the dividend amount payable is also impacted by variations in the inflation rate as it is based upon the principal value of the bond. It may fluctuate up or down. Repayment at maturity is guaranteed by the U.S. government and may be adjusted for inflation to become the greater of either the original face amount at issuance or that face amount plus an adjustment for inflation. TIPS generally have lower yields than conventional fixed rate bonds and will likely decline in price during periods of deflation, which could result in losses.

International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate these risks.

The information provided here is for general informational purposes only and is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, consult with a qualified tax advisor, CPA, financial planner or investment manager.

Mortgage-backed securities (MBS) may be more sensitive to interest rate changes. They are subject to extension risk, where borrowers extend the duration of their mortgages as interest rates rise, and prepayment risk, where borrowers pay off their mortgages earlier as interest rates fall. These risks may reduce returns.

Small-cap stocks have historically been more volatile than the stocks of larger more established companies.

Micro-cap stocks have a market capitalization between approximately $50 million and $300 million. They tend to have greater volatility and less publicly available information. As a result, they are riskier than larger-cap stocks.

Sector investing may involve a greater degree of risk than an investment with broader diversification.

Commodity-related products, including futures, carry a high level of risk and are not suitable for all investors. Commodity-related products may be extremely volatile, illiquid and can be significantly affected by underlying commodity prices, world events, import controls, worldwide competition, government regulations and economic conditions, regardless of the length of time shares are held. Investments in commodity-related products may subject the fund to significantly greater volatility than investments in traditional securities and involve substantial risks, including risk of loss of a significant portion of their principal value.

Risks of real estate investment trusts (REITs) are similar to those associated with direct ownership of real estate, such as changes in real estate values and property taxes, interest rates, cash flow of underlying real estate assets, supply and demand and the management skill and credit worthiness of the issuer. Investing in REITs may pose additional risks, such as real estate industry risk, interest rate risk and liquidity risk.

Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. For more information on indexes please see schwab.com/indexdefinitions.

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