Investing in the stock market can seem very complicated. There's loads of jargon and thousands of shares, OEICs, investment trusts and ETFs to choose from. And there's spreadbetting and CFDs too!
I think the financial services industry like it this way. If it all seems scary and complex, people are more likely to fall for slick sales pitches pushing overly expensive and complex products.
But it doesn't need to be that hard. If you're thinking about investing in the stock market, or you want to simplify your portfolio, I think you could invest in just four ETFs (exchange traded funds) and that would be it. You wouldn't need to think about any other funds or shares, you'd have a simple but sensible investment portfolio that you could leave untouched for years.
Remember, ETFs are just simple funds that enable you to invest in a particular asset simply and cheaply. So you can use these straightforward products as building blocks for a simple investment strategy.
But why invest in the stock market?
Before we go any further with my 4-ETF strategy, let's just quickly consider whether you should be investing in the stock market (a.k.a equities) in the first place.
The big attraction of the stock market is that it's tended to perform better than other assets such as bonds or cash over the long term. By which I mean at least ten years. This isn't always the case - UK Government Bonds have performed better than equities over the last decade - but it's been true for a lot of the time in the UK and US. The only asset that really does as well as the stock market is residential property, but I think it's a mistake to put all your money into houses or flats. You need to spread your risk.
Granted, equities can be very volatile, and that frightens off some investors. But if you're able to invest without being spooked by the volatility, and you can set aside money that you won't need for other purposes, then the stock market could well work for you. It's also crucial that you can invest for at least ten years. That means you're less likely to be forced into selling when share prices are low.
So let's assume that you've now decided to decide to invest in the stock market but you don't want the hassle of picking shares or selecting a wide range of funds. This is where ETFs can help.
Now if you wanted to keep it really simple, you could just buy one ETF that invests in most of the shares listed on the London stock market, and leave it at that. But I think that would be too simple. The London stock market is too concentrated; it has more than its fair share of mining and oil shares as well as a couple of big pharmaceutical firms and plenty of banks too. It doesn't have any big technology companies and it doesn't have enough consumer firms either.
So to get more diversification, I think you should make four investments. You need an ETF covering the UK market, a 'global' ETF that comprises the biggest stocks worldwide, a separate Japan ETF and one for emerging markets. I'd split them using these percentages, but I wouldn't get too hung up on these proportions:
Emerging markets (20%)
I've allocated 30% to the UK market because it is the home market for UK investors. I've put 40% in a global ETF because I want plenty of exposure to the largest companies worldwide. Most global ETFs are heavily exposed to the US market, so you'll be an indirect investor in companies like Amazon, Microsoft, Coca Cola, and Procter & Gamble. You'll also get some exposure to European and Japanese shares.
I've allocated 10% for the Japanese market because I think it's a market well set for further growth, so I wanted extra exposure on top of the global ETF.
And finally, I've put 20% into emerging markets because I think that countries like China and India are the growth engines of the future regardless of concerns about debt and valuation.
And here are four ETFs that could enable you to follow this approach:
SPDR FTSE UK All-Share UCITS ETF FTAL (30%)
This ETF tracks the FTSE All-Share index which comprises around 600 companies on the London stock exchange. It's heavily weighted towards the larger companies - around 80% of the value of this ETF is in the hundred largest companies - but I still think it makes sense to get a bit of extra diversification with the FTSE All-Share rather than the FTSE 100.
The charges are pretty low at 0.2% a year although there are cheaper funds that just track the FTSE 100 such as the iShares Core FTSE 100 UCITS ETF ISF.
You can read about more UK ETFs in Five top UK ETFs.
Xtrackers FTSE All-World ex UK UCITS ETF 1C (40%)
This ETF tracks the FTSE All-World ex UK index. It's a very diverse index with more than 3000 large and mid-cap companies from regions around the world, excluding the UK. Best of all, the top ten stocks only account for 12% of the ETF, so you're not getting huge exposure to a few large stocks.
Top 5 regions
Country/region% of indexUnited States57.4Eurozone9.8Japan8.7Asia - emerging5.4Asia developed5.0
You are, however, getting plenty of exposure to the US market as you can see from the above table. The annual charge is 0.4%.
iShares Core MSCI EM IMI UCITS ETF EIMI (20%)
For my emerging markets ETF, I've gone for this cheap one with an annual charge of just 0.18%. It tracks the MSCI Emerging Markets Investable Markets Index. It comprises around 2700 stocks and includes large, mid-cap and smaller companies across 24 countries.
It's quite heavily weighted towards China as well as technology stocks - technology makes up about 25% of the index. There are other emerging markets indices with less exposure to China which some investors may prefer. But I'm going for this ETF thanks to its cheapness and the fact that I'm relatively optimistic about the prospects for China.
Top 5 regions
Country/region% of ETFAsia - emerging45.2Asia - developed27.9Latin America12.7Europe - emerging6.0Africa5.7
iShares Core MSCI Japan IMI ETF GBP SJPA (10%)
I like this ETF because it gives you broader exposure to the Japanese stock market than rival ETFs which track the better known Nikkei 225. The charge is reasonable at 0.2%.
Top 5 stocks
Stock% of ETFToyota3.4Mitsubishi UFJ Financial Group1.8Sony1.8Softbank1.5Sumitomo Mitsui Financial1.3
I haven't included a specific Europe ETF, so we're only getting a bit of exposure via the global ETF. I didn't want to add an extra ETF because I wanted to keep things simple. But if you want to add a Europe ETF, read Investing in Europe.
You might also consider adding an ETF that focuses on smaller companies across the globe, but again, I don't think it essential and I want to keep this simple.
I've also ignored fixed income. Traditionally, investors allocate some of their cash to fixed income to reduce risk. Fixed income has also performed better than equities for much of the last 20 years. I very much doubt the performance will be strong over the next 20 years. That doesn't mean you shouldn't have any money in fixed income - that's probably for another article.
There are plenty of other attractive ETFs that track the markets I've suggested. Don't feel you have to invest in the ETFs that I've highlighted. The point of this article is to argue that ETFs can enable you to follow a simple investment strategy for the long-term. There will be plenty of volatility along the way, but history suggests that things will probably work out fine by the end.