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Now that both Vanguard and Schwab offer commission free ETFs for clients in their brokerages, an often asked question is which one is better for constructing an asset allocation portfolio. In this article, we discuss the three most important factors in choosing ETFs for portfolio buildings: diversification effect in terms of asset class coverage, strategic and tactical asset allocation strategies using these ETFs, and fees charged.

Asset class coverage

At the first glance, Vanguard offers more ETFs: a total of 49 ETFs that cover a lot more minor assets, compared with Schwab's 15 ETFs. They both cover the five major asset classes: US Equity, Foreign Equity, REITs, Emerging Market Equity, Fixed Income. Here are the lists of minor asset classes each covers:

Vanguard:

Communications
Diversified Emerging Mkts
Diversified Pacific/Asia
Equity Energy
Europe Stock
Financial
Foreign Large Blend
Global Real Estate
Health
Industrials
Intermediate Government
Intermediate-term Bond
Large Blend
Large Growth
Large Value
Long Government
Long-term Bond
Mid-cap Blend
Mid-cap Growth
Mid-cap Value
Natural Resources
Real Estate
Short Government
Short-term Bond
Small Blend
Small Growth
Small Value
Technology
Utilities
World Stock

Asset ClassNumber of funds
Balanced Fund0
REITs2
Fixed Income12
Commodity0
Sector Fund8
Foreign Equity5
Emerging Market Equity2
US Equity17
Other3
Total49

Schwab:

Diversified Emerging Mkts
Foreign Large Blend
Inflation-protected Bond
Intermediate Government
Intermediate-term Bond
Large Blend
Large Growth
Large Value
Mid-cap Blend
Real Estate
Short Government
Small Blend

Asset ClassNumber of funds
Balanced Fund0
REITs1
Fixed Income4
Commodity0
Sector Fund0
Foreign Equity1
Emerging Market Equity1
US Equity7
Other1
Total15

Some observations:

1. Vanguard offers all nine stock styles: large|mid|small cap growth|blend|value stocks while Schwab only offers Mid cap and small cap blends in addition to the complete 3 large blend, large growth, large value.

2. Vanguard offers many sector funds and regional international stock funds while Schwab offers none in these specific sector, regional categories.

3. Vanguard offers several bond minor asset classes while Schwab offers none.

4. However, Vanguard lacks of one important asset class: inflation protected bonds (TIPS) while Schwab offers this category.

5. Finally, both plans do not have anything offered for high yield bond funds, which we consider to be an important asset class.

Portfolio building

With the 5 major asset classes covered, both Vanguard and Schwab offer plenty of diversification to construct a good asset allocation portfolio. The following shows the comparison:

Portfolio Performance Comparison (as of 6/22/2012)

Portfolio/Fund Name1 Week
Return*
YTD
Return**
1Yr AR1Yr Sharpe3Yr AR3Yr Sharpe5Yr AR5Yr Sharpe
Schwab Commission Free ETFs Strategic Asset Allocation Moderate-0.3%4.6%1.3%8.4%
Schwab Commission Free ETFs Tactical Asset Allocation Moderate-0.1%3.6%7.0%91.3%
Vanguard ETFs Strategic Asset Allocation Moderate-0.5%3.2%-1.8%-11.9%13.5%96.4%2.8%12.2%
Vanguard ETFs Tactical Asset Allocation Moderate-0.2%4.7%4.0%36.3%13.0%106.9%7.8%55.3%

Unfortunately, Schwab's ETFs have much shorter history so we can only compare the performance up to 1+ years. Year to day, Schwab's strategic portfolio outperforms Vanguard's while Schwab's tactical portfolio under performs Vanguard's. In the last one year, however, Schwab's portfolios outperform their Vanguard's counterparts by some meaningful margins.

This also tells us that for asset allocation purpose, more funds are not necessarily better as some specific category funds can distract performance (and increase volatility). What is important is the major asset coverage.

For example, Schwab ETFs offer broad base asset class coverage in US equity (SCHX), international equity (SCHF which intends to track the FTSE Developed ex U.S. index. The index is made up of approximately 1,400 international stocks that provides broad exposure to international large and mid cap companies in over 20 developed international markets), emerging market stocks (SCHE which tracks FTSE emerging market index for about 740 companies in emerging markets), U.S. REITs (SCHH that tracks Dow Jones US REITs Index) and US total bond market index (SCHZ). These funds are sufficient to build a very diversified portfolio.

The tactical asset allocation portfolio mentioned above uses cross asset trend following to dynamically increase or reduce allocations to risk assets (stocks and REITs). At the moment, for example, the portfolio identifies that the only risk asset that is worth exposure is US REITs, which both Schwab and Vanguard tactical portfolios hold.

Fees

Vanguard is by far the low cost ETFs leader. However, to compete against Vanguard (and other providers), Schwab has been really aggressive in terms of their ETFs expenses. We tallied out the expense ratios for funds held in the two strategic portfolios:

Vanguard ETF Strategic Asset Allocation Moderate

Holdings (As of 06/22/2012)

AssetFund in this portfolioExpense RatioPercentage
US EQUITYVYM0.13%9.34%
US EQUITYMGK0.12%3.58%
REAL ESTATEVNQ0.1%14.12%
Emerging MarketVWO0.2%13.36%
INTERNATIONAL EQUITYVT0.06%17.64%
FIXED INCOMEBND0.1%41.96%

Schwab Commission Free ETFs Strategic Asset Allocation Moderate

Holdings (As of 06/22/2012)

AssetFund in this portfolioExpense RatioPercentage
INTERNATIONAL EQUITYSCHF0.13%13.75%
US EQUITY 0.08%8.31%
US EQUITYSCHD0.17%6.58%
Emerging MarketSCHE0.25%12.16%
FIXED INCOME 0.1%42.57%
REAL ESTATESCHH0.13%16.63%

In general, Vanguard ETFs have lower fees than Schwab's. But they are very close. Also bear in mind that Vanguard's fees were recently lowered. We hope Schwab can respond and lower their fees too.

In conclusion, both Vanguard and Schwab ETFs are very competitive and good enough to allow their customers to build diversified, high quality and low cost portfolios using both strategic and tactical asset allocation strategies.

Source: Vanguard Vs. Schwab: Who Has The Best Suite Of Commission Free ETFs For Portfolio Building