Total Stock Market ETFs vs. Slice 'n Dice

By Murray Coleman

Matt Hougan seems to think the world will be a much safer place for all of us if there were more one-stop shopping stock funds. In the indexing world, those are known as Total Stock Market [TSM] portfolios.

Up to this point, you could only get those in two flavors -- international and domestic. Now, one fund can do it all. But the fact is that neither the newly launched iShares version or the upcoming Vanguard global TSM will have much in the way of small-cap exposure.

Of course, TSM proponents argue that's the way the market likes it. (More to the point, whether you like it or not, that's the way the market IS ... resistance is futile!)

Fine, but these first new set of global TSM funds are going to act a lot like large-cap dominated blend funds. Just look at SPY vs. VTI. In the past 10 years, the S&P 500-hugging SPY has an average annualized return of 3.4%, according to Morningstar. In the same timeframe, VTI's other half (Vanguard Total Stock Market Index) has gained a whopping 3.8%.

See what we have to look forward to, folks? Domestic TSM, with its 10% or so in small-caps and tiny amount more in mid-caps is going to look a lot like these humongous global TSM portfolios. Namely, they'll have just enough of everything to stir the pot. But it won't make a very fulfiilling, hearty stew.

The point is ... will these new global TSM ETFs really offer that much true diversity? Or, will their promise fade as returns show that you've really got to take a bit more interest in working on a proper allocation to meet your long-term investment goals?

Global TSMs are better than nothing. But I just wonder if this is a further dumbing down of a popular investment vehicle ... ETFs, that is, not global diversification.

Comments

[galeno]

Emergency funds = Sufficient

Debt: None

Age: 50

Situation: Married couple with children. Spouse aged 50. Four children aged 21, 18, 13, and 11. Early retirement planned for July 2009. No future pensions or company sponsored healthcare. Minimal Social Security benefits in 12 to 20 years. 100% of early retirement living expenses must come from the retirement portfolio.

Desired Asset allocation: From 60/10/30 sliced and diced to 70/0/30 lumped (stocks/hard assets/bonds)

Intl allocation: Ranging from 50% of stocks in sliced and diced portfolios to 0% in the lumped portfolio.

Portfolio size = Sufficient

Planned Initial Annual Withdrawal Rate: Minimum 3.00% to maximum 3.60% assets per year.


I. THE PORTFOLIOS


A. Totally Sliced and Diced Portfolio

US Stocks 30%
6.25% VTI (US Large Cap Core)
6.25% VTV (US Large Cap Value)
6.25% VB (US Small Cap Core)
6.25% VBR (US Small Cap Value)
5.00% VNQ (US REIT)

Non-US Stocks 30%
10% VEU (Non-US Large Cap Core)
5% GWX (Non-US Small Cap Growth)
5% DLS (Non-US Small Cap Value)
5% VWO (Emerging Market Large Cap Core)
5% WPS (Non-US REIT)

Hard Assets 10%
5% GLD (Gold)
5% DBC (Commodities)

Fixed Income 30%
15% USD 1yr CD
15% BWX (Non-US Treasury Bond ETF)

B. Cheaply Sliced and Diced Portfolio

US Stocks 35%
8.75% VTI (US Large Cap Core)
8.75% VTV (US Large Cap Value)
8.75% VB (US Small Cap Core)
8.75% VBR (US Small Cap Value)

Non-US Stocks 35%
35% VEU (Non-US Large Cap Core)


Fixed Income 30%
30% USD 1yr CD

C. Lumped Portfolio

US Stocks 70%
70% VTI (US Large Cap Core)

Fixed Income 30%
30% USD 1yr CD


II. PORTFOLIO STATISTICS

A. Federal Tax Rate (Ratio) = X% of total portfolio per year

Totally Sliced = 0.50%
Cheaply Sliced = 0.33%
Lumped = 0.44%

B. P/E of stock portfolio TTM (with REITs)

Totally Sliced = 17.11
Cheaply Sliced = N/A
Lumped = N/A


C. P/E of stock portfolio TTM (minus REITs)

Totally Sliced = 14.03
Cheaply Sliced = 15.04
Lumped = 15.97


D. Portfolio Net Yield = X% [Gross Yield - Total Expense Ratio (Bernstein-Galeno)]

Totally Sliced = 1.11%
Cheaply Sliced = 1.85%
Lumped = 2.37%

E. Stated Expense Ratios = X% of total portfolio

Totally Sliced = 0.76%
Cheaply Sliced = 0.34%
Lumped = 0.08%

F. Total Expense Ratios (Bernstein-Galeno) = X% of total portfolio (Expense Ratios + Commissions + Bid-Ask Spreads + Impact Costs + Tax Ratio + Rebalancing Costs)

Totally Sliced = 1.25%
Cheaply Sliced = 0.67%
Lumped = 0.53%


G. Rebalancing Costs = X% of total portfolio per year
Totally Sliced = Undetermined. Assume zero at this time.
Cheaply Sliced = Undetermined. Assume zero at this time.
Lumped = Undetermined. Assume zero at this time.


H. Frictionless (cost-free) Real (inflation adjusted) Annual Portfolio Growth Rate Assumptions going forward: 2% for fixed income and hard assets. 4% for US and Foreign large caps. 6% for US and Foreign small caps and REITs.

Totally Sliced = 3.95%
Cheaply Sliced = 3.75%
Lumped = 3.40%

I. NET Real (inflation adjusted) Annual Portfolio Growth Rate Assumptions going forward: [Frictionless REAL Annual Growth Rate] – [TER-Bernstein-Galeno]

Totally Sliced = 3.97 – 1.25 = 2.70%
Cheaply Sliced = 3.75 – 0.67 = 3.08%
Lumped = 3.40 – 0.53 = 2.87%



III. SCENARIOS:

A. Over 50 years, $10,000 in a Totally Sliced and Diced Portfolio will grow to a frictionless (cost free) inflation-adjusted $69,378. Net of TER-Bernstein-Galeno costs, this will grow to $37,990. The investor will capture 54.6% of the frictionless terminal value while financial croupiers (“Wall Street” and the IRS) will rake in 45.4%.


B. Over 50 years, $10,000 in a Cheaply Sliced and Diced Portfolio will grow to a frictionless (cost free) inflation-adjusted $63,009. Net of TER-Bernstein-Galeno costs, this will grow to $45,754. The investor will capture 72.3% of the frictionless terminal value while financial croupiers (“Wall Street” and the IRS) will rake in 27.7%.


C. Over 50 years, $10,000 in a Lumped Portfolio will grow to a frictionless (cost free) inflation-adjusted $53,214. Net of TER-Bernstein-Galeno costs, this will grow to $41,156. The investor will capture 77.3% of the frictionless terminal value while financial croupiers (“Wall Street” and the IRS) will rake in 22.7%.

IV. COMMENTS:

Not taking into account rebalancing costs or anything that I’ve either missed or miscalculated, it appears that the Cheaply Sliced and Diced Portfolio is the way to go here.

Conclusion here is that slicing and dicing a portfolio is good up to a point. The costs of slicing and dicing for an indexed portfolio may be very important.

Even indexed portfolios are expensive when you look at total costs which include Expense Ratios, Commissions, Bid-Ask Spreads, Impact Costs, Taxes, and Rebalancing Costs (uncalculated at this time).

Between “Wall Street” and the IRS, an indexed portfolio investor using the above portfolios will still sacrifice 45.4%, 27.7%, or 22.7% respectively of the 50 year terminal values to these financial croupiers who put up 0% of the funds and take 0% of the financial risk.

V. QUESTIONS:

Is there anything I’ve missed or omitted before “dissing” the asset-class junkie’s preference (i.e. my own addiction) for extremely sliced and diced portfolios?

Comments and or questions are welcome.