Many investors think that diversification is complex. I, on the other hand, think proper equity diversification is remarkably simple. Here is a stock portfolio that's about as diversified as it gets, yet only uses two funds.1) Vanguard Total Stock Index (VTSMX, VTSAX, or VTI)
2) Vanguard Total International Stock Index (VGTSX, VTIAX, or VXUS)
Vanguard Total Stock Market Index
With expense ratios as low as 0.07 percent, investors can own virtually every publicly held company based in the United States. This fund offers exposure to large, mid-sized, and small companies, as well as value, growth and core companies. In fact, you get this exposure in the same allocation that Morningstar defines as the US stock market. You also get every sector of the US stock market.
Now the same portfolio could certainly be built using nine different index funds, but you'd pay more fees and find yourself having to rebalance, taking more of your time and causing you to pay more in taxes. I say own the entire US stock index and forget about rebalancing within US stocks.
Vanguard Total International Stock Index
With this single fund, you own nearly every publicly held company based outside of the United States. It's virtually the counterpart of the Total US stock fund, though, with a 0.20 percent expense ratio, costs are higher. This is the first, and to my knowledge still the only, fund that owns developed markets, Canada, and emerging markets. It owns large, mid sized, and small companies along with value, growth and core.
Putting the two together
An even simpler solution would be to buy a single world index fund. I opt not to use, or recommend, them because they don't own small cap companies and sometimes leave out mid cap companies. I also like to overweight US stocks for my own portfolio, as I will spend down my portfolio with a greater proportion of products and services from the US, and recommend two-thirds US and one-third international. Granted, weighting to a market cap of about 45 percent US and 55 percent international could be considered more diversified.
More funds equals less diversification
Any other purchase of equities or equity funds will equate to less diversification. If I buy more small cap and value funds, then I am making a bet that small cap and value will outpace the rest of the stock market and am accepting additional risk for that expectation. Though I may be right, I am less diversified.
Plain and simple, any other fund or direct purchase of a stock is going to be overweighting some portion of my equity portfolio, making me less diversified.
My own portfolio has two alternative assets classes -- REITs and a precious metals and mining fund. There is an argument that this is greater diversification. I'll address the argument in my next piece, as well as explain why I have done so and why you might want to proceed with caution.
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