Build a portfolio with 3 ETFs in 2025
Some investors enjoy the art of investing. They enjoy the intellectual challenge of crafting a portfolio. For others, investing is a means to an end. They want a simple portfolio that gets the job done.
Bogleheads follow the advice of their investing mentor, Vanguard founder John Bogle who advocated for a 3 ETF portfolio that provided exposure to domestic and global shares along with fixed interest. There has been a surge of new ETFs that cover narrower and narrower parts of the market. Bogle likely would have suggested investors ignore these niche products.
A diversified portfolio does not mean an investor needs to own everything. There are some asset classes missing from this mix, such as real estate or alternatives. Bogle believed in simplicity. The more straight forward your portfolio, the less time you would spend worrying about it. That means it is less likely you would change things around during volatile markets. Investors tinker at their peril.
When you’re holding three ETFs, it is important that they are as broad and representative as possible. One of Bogle’s most famous quotes is ‘stop trying to find a needle in a haystack and own the haystack.’
Most investors would benefit from following Bogle’s approach since trying to beat the market is not usually a winner’s game. Morningstar’s Active Passive Barometer shows that 29% of active managers beat their passive counterparts. Investing is one of the rare pursuits in life where getting the average return is more than enough to achieve your financial goals.
There is a difference between passive investments and passive investing. Far too many investors take an active approach with passive investments and try and time the market. This doesn’t work. Morningstar explores the difference between the returns that investors get and the returns of the investments they buy and sell. There is a gap which is the result of investors buying and selling at the wrong time. In a recent iteration of the Morningstar Mind the Gap study investors underperformed their investments by 1.60% a year. Passive investing is a set and forget approach.
One of the biggest benefits of passive investing is low fees. When picking any investment product, consider the value you are getting for the price you are paying. For passive ETFs, the fee should be minimal as it requires no active stock picking or large investment teams. Even small differences in fees matter over the long-term.
With that in mind, I’ve used insights from Morningstar researchers to run through how to pick 3 ETFs for a simple portfolio.
Global equity
It’s important to understand what you are investing in. When it comes to passive global equity you are going to get a large chunk of exposure to the United States.
For example, if we look at the MSCI World ex-Australia Index, 75% of the index is made up of companies based in the United States (at Dec 31 2024). Many Australians have a home bias, with a large tilt towards Australian equities in their portfolio. This exposure to the United States includes some of the world’s most noteworthy companies, including sectors that are underrepresented in Australia such as technology and healthcare.
It’s also worth noting that in a globalised world where a company is listed doesn’t tell the whole story. Many large US companies are multinationals. They sell their products around the world which provides a more nuanced exposure than the country they are listed or headquartered in.
The other option with international exposure is to look at tilts – whether that be sector, geography or size. For this exercise, we are following Bogle’s lead and creating a simplified portfolio where broad exposure is the name of the game.
Our analysts’ preferred choice for core global equity exposure is the Vanguard MSCI International ETF VGS. They cite cheap fees, broad diversification and Vanguard’s track record of being able to match the index returns. VGS bags a Gold medalist rating from our analysts.
The investment is low cost with an 0.18% fee. Due to it being frequently traded, it has a low buy/sell spread. This is an underappreciated cost of trading and will make a difference if you are frequently making additional investments.
Australian equity
Australian equity exposure is the crowd favourite. Many of us have concentrated exposure to the asset class in our portfolios. There are a few ways to approach domestic equities. But first, you need to get familiar with the market to make an informed decision.
Let’s take a look at the S&P/ASX 200 Index. The Australian market is highly concentrated in two industries – mining and financial services. These companies are cyclical. It means that 85% of the market is allocated to companies that have a high correlation to economic conditions. The second, is that it is top heavy. The big hitters take up a large part of the overall index, with the top 10 making up 48% of the index. This includes 20% of the index allocated to CBA and BHP.
There are ways to minimise the risk that this concentration brings. Investors could opt for an equal-weighted ETF that invests equally across all constituents. They could also look at tilts for their portfolio if they are looking to achieve particular goals, like income. Income is a goal for many investors and the Australian market delivers, with a yield that surpasses most other global markets. As an added bonus, Australian investors get rewarded with franking credits which have, on average, added 1.34% p.a. to investor returns in the last three years. That’s hard to dismiss.
The SPDR S&P/ASX 200 ETF STW is a credible low-cost option for investors seeking passive exposure to Australian equities. It was awarded a Bronze medalist rating from our analysts.
Fixed Income
There are a few considerations with fixed income ETFs. The first is the running yield. This is the annual coupon payment of the bonds in the portfolio, divided by their current price. This will change over time but will give you a snapshot of the interest payments you will receive. That is one component of returns in fixed interest.
The other is changes in prices. Bond prices are impacted by interest rates. The level of impact is measured by a metric called duration. If, for example, an ETF had a duration of 5, that indicates that if interest rates rise by 1%, the price will fall by 5%.
In the past few years, active bond managers have done well – on average, beating their passive rivals. In general, active managers possess the flexibility to adjust to interest-rate changes, whereas passive investments are bound to the benchmark with minimal control over their risk profile. For instance, the period of rising interest rates through 2021 and 2022 was a favourable environment for active managers to showcase their abilities. However, over the long term, few are able to beat the benchmark consistently.
For fixed income exposure our preferred choice is iShares Core Composite Bond ETF IAF. Our analysts believe it is a high quality and low-cost way to access to Australian fixed income.
It’s cheap, at 0.10% and has low tracking error which means that you are getting the index return. In this case, the index is the Bloomberg AusBond Composite index. This index is mostly government bonds, but also has exposure to corporate bonds. Running yield is currently 3.21% and duration is 4.86 (at 21 January 2025).
Morningstar analysts award IAF a Gold Medalist rating and considers it excellent low-cost access to Australian fixed income.
More important than the ETFs you choose
The most important decision an investor can make is how to allocate funds between different asset classes. This is true if your portfolio has three ETFs or 50 holdings. Asset allocation has a far bigger impact on returns than the individual securities that are selected.
The higher the return needed to achieve your goals, the more that should be allocated to the growth assets which consist of the two equity picks. In Morningstar’s most aggressive portfolios for investors with long time frames, 90% is allocated to growth assets.