The Penny-Pincher's All-ETF Portfolio

 |  Includes: BND, BSV, SCZ, VB, VBR, VGK, VPL, VTI, VTV, VWO
by: IndexUniverse

By Murray Coleman

A lot of pundits are telling you to start bottom-fishing for stocks. That might be true since many blue-chip companies are trading at ridiculously low valuations.

But such short-term moves can be difficult to turn into long-term gains. Instead of focusing on trying to time markets, another strategy might be to put your portfolio's fee schedule under the same microscope as its returns.

The average mutual fund's expense ratio now is 1.24%, according to Morningstar. That means for every $100,000 you've set aside, you're forking over $1,240 a year in administrative-related fees.

So let's do some penny-pinching. You can easily set up a portfolio of exchange-traded funds that would come with a total expense ratio of 0.12% to own. Such a miserly basket of 60% stocks and 40% bonds would set you back $120 per every $100,000 invested. And it'd be widely diversified with plenty of room to grow through nine different funds.

The Penny-Pincher's All-ETF Portfolio

ETF Symbol ER % Category Weight % YTD Return %
Vanguard Total Stock Market VTI 0.07 U.S. Large-Cap 10 -6.91
Vanguard Value VTV 0.10 U.S. Large Value 10 -10.79
Vanguard Small Cap Value VBR 0.11 U.S. SC Value 10 -11.75
iShares EAFE Small Cap SCZ 0.40 Int'l Dev. SC 5 -10.07
Vanguard European Stock VGK 0.11 Int'l Dev. LC 10 -11.89
Vanguard Pacific Stock VPL 0.11 Int'l Dev. LC 10 -10.93
Vanguard Emerging Markets VWO 0.25 Int'l Emerging 5 -6.92
Vanguard Total Bond Market BND 0.11 U.S. Bonds 30 -3.13
Vanguard Short-Term Bond BSV 0.11 U.S. Bonds 10 -1.58
Click to enlarge

But it's important to realize what such a portfolio doesn't include. As a confirmed penny-pincher, you've got to just say no to high-priced funds.

For example, it certainly might be advantageous in the long term to include an international small-cap value ETF. And since the iShares EAFE Small Cap Index (NYSE: SCZ) provides only developed markets exposure, it might be nice to have a bit of emerging markets coverage to juice returns down the road.

But you're going to start really paying up for those types of features. (In an earlier Long Road column, we studied low-cost foreign small-cap alternatives. See the story here.)

It's like buying a car—you've got to walk into the showroom knowing how much is enough. Stick with the basic features needed and stick to a set allocation plan, which is what will drive a majority of your returns over time.

(A side note: Vanguard has a new FTSE All-World ex-US Small-Cap Index ETF set to launch soon. It will provide exposure for both emerging and developed markets and come slightly cheaper than SCZ. See related story here.)

With pure small-cap value ETFs starting at around 0.60%, a more cost-conscious strategy might be to get most of your exposure to that style of stock in the U.S. The price differences are startling. The Vanguard Small Cap Value ETF (NYSE: VBR) comes with a much easier-to-swallow 0.11% expense ratio—a fifth the cost of its closest foreign rivals. In order to remain diversified, a true penny-pincher would dabble in small-cap stocks overseas without going overboard.

A Globally Diversified Approach

Still, you'll notice the Penny-Pincher's Portfolio is equally split in its stock allocations between domestic and international weightings. Although there are some bargain-basement ETFs that fold coverage of non-U.S. developed markets under one umbrella, you're still paying more for such conveniences. By splitting your large-cap international exposure into a pair of separate ETFs, you can actually shave expenses.

Another nice result of going with two instead of one in developed foreign markets is that you have some added flexibility. Funds tracking the widely followed MSCI EAFE index had 65.7% devoted to Europe and 34.3% to Pacific markets heading into 2009. In the Penny-Pincher's Portfolio, half of the amount allocated to international large-cap developed markets goes to the Vanguard European Stock ETF (NYSE: VGK). The rest goes to its sister Pacific Stock ETF (NYSE: VPL).

The result is that Asia is overweighted in this model portfolio. But since both VGK and VPL cost the same, you can easily tweak weightings to more closely track broad market-cap-sized indexes such as the EAFE.

The portfolio also doesn't hold specific funds focusing on mid-cap stocks. That's due to the fact that the Vanguard Total Stock Market ETF (NYSE: VTI) covers the entire U.S. spectrum. Although it's mainly weighted in large-caps, it holds a notable contingent (about 20%) of mid-caps as well. Small-caps are also provided, although at levels (around 10%) some might feel could be spruced up a bit.

And as a so-called blend fund, VTI's smaller names are spiced liberally with more growth-oriented small-cap stocks. Allocating another 10% to VBR creates a nice style mix that also tilts the entire portfolio to the value side, which over the long term has shown a tendency to help improve overall returns.

Other Slicing & Dicing Options

Along those lines, you can also add some Vanguard Value ETF (NYSE: VTV). In the downturn of 2000-2002, it didn't fall quite as hard as VTI, which holds both growth and value stocks.

Of course, value has been slammed during the current credit crunch. So you could nix VTV and just go with VTI, which would save even more in expenses. And if you wanted to go more middle-of-the-road with small-caps, the Vanguard Small-Cap ETF (NYSE: VB) offers a blended approach with an expense ratio of 0.10%.

The Penny-Pincher's Portfolio won't be for everyone. It requires a level of comfort with using a total markets approach to gain broad coverage to niches such as mining, real estate investment trusts and companies exposed to commodities. Buying specialized funds to overweight sectors isn't in the game plan.

It's certainly not something to be taken carte blanche without consulting an adviser or some other knowledgeable investor you know and trust. The Penny-Pincher's Portfolio is being presented here as a building block to show what's possible.

And remember that in past Long Road columns, we've explored discount brokerages now offering transaction-free trading in ETFs. We've also written about several others now charging pennies on the dollar in commissions to buy ETFs.

The bottom line is that no matter how you choose to do it, pinching pennies in these tough economic times should be a no-brainer.