The Core ETF You Need to Own

This week and last, we're presenting 10 core stock ideas -- stocks our writers believe can serve as the foundation for a long-term-focused portfolio. Today we are presenting a bonus "core" holding, this one an exchange-traded fund.

While individual stock pickers may enjoy the process of researching and monitoring several dozen companies, that approach isn't for everyone. For investors who want to save some time and get wide exposure to the stock market in one shot, a low-cost exchange-traded fund is the way to go. Even stock pickers can benefit from adding a core ETF to their holdings, which will instantly diversify and broaden any portfolio.

The business
Vanguard Total Stock Market ETF (NYSE: VTI) is hands-down one of the best core exchange-traded funds for virtually any investor. The fund tracks the MSCI U.S. Broad Market Index, which consists of all domestic stocks on the NYSE and Nasdaq markets. The fund typically holds between 1,200 and 1,300 of the stocks in the target index. You won't leave the market in your dust with this fund, but you will get well-diversified exposure for a next-to-nothing price tag.

Source: Google Finance. ROE = return on equity.

Since its June 2001 inception, this fund has posted an annualized 1% return through August 2010, compared to a completely flat showing for the S&P 500 Index. That isn't a huge difference, but for a passively managed investment that's not aiming to beat that market, that's not too shabby! Turnover is a low 5% here, so the fund can be utilized in both tax-advantaged and taxable accounts without worrying about excessive capital gains.

Vanguard Total Stock Market ETF is a well-rounded fund option that is suitable for investors of all stripes. That's why we recommend the fund in all of the model portfolios we've created in the Fool's Rule Your Retirement investment service. From the youngest, most aggressive investor to gun-shy retirees who shun unnecessary risk, this fund has something for everyone, thanks to its broad mandate.

Why it's a core ETF
When it comes to ETF investing, there are two simple keys to success -- keep it cheap and keep it broad. I recommend folks stay away from narrowly focused, specialized funds that only invest in one particular industry or country, especially if they are leveraged or inverse leveraged funds. Specialty funds like these are not only more risky than most investors need for their portfolio, but they typically come with higher price tags -- in some cases, even higher than most actively managed mutual funds. That's why investors should stick to the ETF basics. Vanguard Total Stock Market meets the criteria for broad and cheap in spades.

If you're looking for inexpensive, wide-market coverage, you won't do much better than this fund. Vanguard Total Stock Market ETF clocks in with a rock-bottom 0.07% expense ratio, the cheapest exchange-traded fund in existence, with only one exception. Another popular broad-market ETF, the SPDR S&P 500 ETF (NYSE: SPY), sports a 0.09% annual price of admission, which isn't a whole lot more than the Vanguard fund, but over time even small fees can add up and eat away at your returns.

The fund invests across the market capitalization spectrum, but as can be expected for a market-cap-weighted index, big-name blue chips tend to take the spotlight. Splashier growth name Apple (Nasdaq: AAPL) and value-priced Microsoft (Nasdaq: MSFT) from the tech arena stand alongside more staid consumer and health-care stocks such as Procter & Gamble (NYSE: PG) and Johnson & Johnson (NYSE: JNJ) to provide balanced exposure to the entire stock market . Midsized and small-cap names account for roughly 20% and 6% of assets, respectively.

Risks
The biggest risk involved in owning Vanguard Total Market Stock ETF is market risk. Because the fund contains thousands of names, individual blowups won't affect the portfolio. But macroeconomic conditions and the general market environment will be both the primary drivers and risk factors here. If another market meltdown happens, this fund won't protect you from that carnage.

And while this isn't a risk inherent in owning the fund itself, I think it warrants mentioning that while the fund attempts to capture a wide swath of the domestic stock market, it does emphasize large- and mega-cap stocks rather heavily. So unless you own a handful of individual small-cap stocks elsewhere in your portfolio, you might want to also stock up on another ETF that invests exclusively in small-fry companies, like the Vanguard Small-Cap ETF (NYSE: VB).

In sum
While you can't build a diversified portfolio with just one stock, you can come pretty close to accomplishing that task with just one exchange-traded fund. The Vanguard Total Stock Market ETF is an ideal core holding for any portfolio, thanks to its broad market coverage and low expenses. If you buy just one ETF this year, make it this one.