Dear Dr. Don,
With all of the emphasis being put on diversification, what is the best and most economical way to purchase individual exchange-traded funds, or ETFs, and/or mutual funds on an ongoing basis? For example, what if you wanted a diversified portfolio having 30 percent invested in bonds, 10 percent in foreign investments, 10 percent in commodities, 30 percent in large-cap and 20 percent in small-cap stocks? Is there an economical way this asset allocation arrangement should be purchased each month? For someone putting in $1,000 a month through a retirement plan, it can be quite an undertaking to do this on a regular basis. Any suggestions or insight you can offer would be appreciated.

— Will Wealth

Dear Will,
Your goal is easily accomplished. Any 401(k) or 403(b) plan worth its salt allows you to buy fractional shares in mutual funds or ETFs. You can indeed buy your targeted asset allocation each month by putting 30 percent in bonds, 10 percent in foreign investments, 10 percent in commodities, 30 percent in large-cap and 20 percent in small-cap stocks.

If you are doing all or part of this in a Roth or traditional individual retirement account, then an automatic investment plan, or AIP, can accomplish the same goals. The sticking point is if there are minimum initial purchases for a mutual fund. Company retirement plans often are able to ignore these minimum purchase requirements, and that may also be true in an IRA when investing using an AIP. In essence, you are dollar averaging your retirement investments by spreading the $1,000 per month among your chosen investments.

I’m not going to solve the question of ETFs versus mutual funds here. Consider your investment goals, how frequently you expect to trade the portfolio, and keep an eye on minimizing your annual fees and expenses.

Exchange-traded funds have an advantage in that the investments can be traded intraday, and they often have lower annual expense ratios. But the disadvantage is that you typically pay a brokerage fee to buy or sell ETF shares. ETFs can provide ways to hedge your portfolio and expand the universe of investment options that are not readily available in mutual funds, but these investments are best utilized by investors with a good understanding of how they work.

Mutual funds trade at the end of the business day, may have limits on trading — including additional fees for short-term trading — and can have higher expense ratios.

I tend to think that retirement investors shouldn’t be day trading their retirement nest egg, so ETF intraday trading isn’t all that important.

Even periodic rebalancing of the portfolio to bring it back in line with stated asset allocation goals is easily accomplished. You can sell shares of ETFs or mutual funds within your retirement account without creating any tax obligation.

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