Most investors understand the point of diversifying a portfolio of stocks is reducing your overall risk. To this end, the Motley Fool recommends holding at least 50 individual stocks at any given time. The top potential problem with that plan? Not everybody has the time or inclination to pick or keep tabs on that many tickers.
Fortunately, there's a simple solution. That's exchange-traded funds, or ETFs, which are simply baskets of stocks bought and sold as a single unit. It's easy — and instant — diversification. You could be more than amply diversified with just three ETFs, in fact, without crimping any of your potential upside.
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Here's a closer look at all three such funds below.
It won't come as any surprise to most veteran students of the stock market that your first best ETF pick is the SPDR S&P 500 ETF Trust (NYSEMKT: SPY), which of course mirrors the performance of the S&P 500. This cap-weighted index and fund holds 500 different names, encompassing over 80% of the entire U.S. market's total value. It is, for all intents and purposes, a proxy for the stock market itself.
No, you won't beat the market with this fund. You'll merely match its long-term performance. But that's ok. The odds of you outperforming the market by picking individual stocks or even most other funds are actually pretty low.
For perspective, Standard & Poor's reports that for any given time frame, about three-fourths of mutual funds available to U.S. investors underperform their benchmark index. And hedge funds' performances are even worse. This reliable underperformance suggests that the very effort to outperform the S&P 500 may be the very reason most of them don't do so.
Whatever the reason, the statistical odds say you'll likely do better by not trying to beat the market but rather being satisfied with its overall long-term performance of an average gain of about 10% per year. Oh, and if you're a fan of Vanguard funds, the Vanguard S&P 500 ETF (NYSEMKT: VOO) will do just as well as SPY.
Once you've laid the foundation with the SPDR S&P 500 ETF Trust or the Vanguard S&P 500 ETF, it's time to add something that won't necessarily lead or lag the broad market but perform differently — and at different times — than the S&P 500 Index.
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