A Commission Free Portfolio That Can Beat The Market

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Includes: BLV, IWN, MGK, TIP, VB, VEA, VNQ, VO, VPU, VWO, VYM
by: Brian Burns

Summary

It is possible to beat the market with a diversified portfolio of ETFs.

The ETFs listed in the portfolios below are all commission free.

A well structured portfolio of ETFs will save you time and trading costs.

Investing involves risk and cost. As you are probably well aware, any time you put your money to work, there is a possibility that it will get "fired". And what if your money is lazy? What if it doesn't deliver the returns you had expected? How much time do you need to research individual stocks? Are you spending time researching stocks, trading, and worrying about your investments only to realize that you didn't beat the market, yet again? You may be underperforming the market consistently and not know the reasons why.

The beautiful thing about investing is that there is always another way. I tend to follow a more conservative approach to my investments in that I shy away from owning individual stocks. Of course, if you have the time to do enough research and carefully pick your stocks you may do very well. However, you may also lose big due to unforeseen circumstances at any one particular company. When investing in individual stocks it only takes a few losers to drown your performance.

I'm a simple man and I want my investments to be as simple and easy as possible. I want to be diversified and yet be able to keep up with or consistently beat the market without doing much work. Remember the Ron Popeil saying? "Set it, and Forget it!"

There is a way to lower your exposure to individual stocks by investing in ETFs. There is also a way to build a diversified portfolio completely commission free. For the year of 2014, I constructed a commission free portfolio that generated decent returns without the stress and time needed to research and pick individual stocks.

The fact that these ETFs are commission free makes it great for an IRA or any account that you may be averaging money into. Also, rebalancing is not an issue because, again, there are no transaction costs. The ETFs listed are part of the commission free program available at TD Ameritrade. There is no cost to be enrolled in the program and they have about 100 commission-free ETFs. The only time you would be charged a trading fee is if you sell the ETF that you purchased in less than 30 days. I also know that Fidelity has a similar program which contains about 70 commission-free ETFs.

I have two different portfolios set up. Both are set up with the base of investing $10,000 as of January 1, 2014. The first one is a more aggressive equity portfolio which contains a 77.5% equity exposure as follows: US Small Cap 15%, US Mid Cap 25%, US Large Cap 27.5%, International Equity 10%, Real Estate 10%, Bonds 12.5%. The International equity is split between emerging markets and developed markets.

Below are the % breakdowns and the performance of the 1st portfolio. At the bottom of the article is a detail of the type of ETFs used in the portfolio:

Investment Type

Symbol

% Asset Allocation

% Return

Total Return % with Dividends

Small Cap

IWN

7.5%

2.52%

4.45%

VB

7.5%

6.35%

7.87%

15.0%

Mid Cap

VO

25%

12.68%

14.13%

25.0%

Large Cap

MGK

7.5%

12.50%

13.46%

VYM

10.0%

10.66%

13.73%

VPU

10.0%

23.09%

25.81%

27.5%

International

VEA

5.0%

-8.10%

-4.72%

VWO

5.0%

-1.21%

1.61%

10.0%

Real Estate

VNQ

10.0%

26.01%

30.55%

10.0%

Bonds

BLV

6.25%

14.77%

19.25%

TIP

6.25%

1.84%

3.53%

12.5%

Totals

100.0%

11.32%

13.74%

The total return of the portfolio including dividends was 13.74%. Of course, if this was in a taxable account, you would be forced to pay tax on the dividends which would come out to an adjusted return of 13.38%. This isn't bad considering the exposure to the international markets didn't help at all this year. The beginning of 2015 would have been a great time to rebalance this portfolio and let it ride again for another year.

Some people would prefer not to have real estate exposure and some would like a commodities mix. I agree that adding commodities seems like a great idea for added diversification. There are commodity based Mutual Funds from TD Ameritrade that are also commission free so this can be done with no additional headaches.

Also, many portfolio guidelines state that exposure to international bond markets is a must. I think that is fine if you want to have that exposure and there are specific commission free ETFs geared to that as well. Although the BLV is mainly a U.S. Bond fund, it does have some international exposure so that was fine with me.

I set up the next portfolio to be more conservative. At least, following the standard of more conservative = more bonds. However, I'm not sure a high bond strategy will work as well this year. Particularly if interest rates start being raised or inflation becomes an issue.

This second portfolio is set up with a 45% total equity exposure as follows: US Small Cap 4%, US Mid Cap 18.5%, US Large Cap 18.5%, International Equity 4%, Real Estate 5%, Bonds 50%. The International equity is split between emerging markets and developed markets.

US Stock

Symbol

% Asset Allocation

% Return

Total Return % with Dividends

Small Cap

IWN

2.0%

2.52%

4.45%

VB

2.0%

6.35%

7.87%

4.0%

Mid Cap

VO

19%

12.68%

14.13%

18.5%

Large Cap

MGK

3.5%

12.50%

13.46%

VYM

5.0%

10.66%

13.73%

VPU

10.0%

23.09%

25.81%

18.5%

International

VEA

2.0%

-8.10%

-4.72%

VWO

2.0%

-1.21%

1.61%

4.0%

Real Estate

VNQ

5.0%

26.01%

30.55%

5.0%

Bonds

BLV

25.00%

14.77%

19.25%

TIP

25.00%

1.84%

3.53%

50.0%

Totals

100.0%

11.07%

13.76%

After tax considerations this portfolio will have a return of 13.36%. As you can see, this conservative approach actually had a slightly better return before taxes and slightly less after taxes. This was due to a greater exposure to BLV which had a phenomenal year for a bond fund. I don't think that will be the case this year and if bonds underperform so will this portfolio. Also, the lower exposure to the emerging market funds which underperformed during the year of 2014 also helped. Again, rebalancing the portfolio is a must as it enables you to sell assets that have appreciated and buy assets that have fallen in value. In a sense, buy low, sell high.

As a check, the 2014 returns for the major indexes were as follows:

DOW

7.55%

S&P

11.54%

NASDAQ

13.85%

Below is a detail of the ETFs used in the portfolios.

SMALL CAP EQUITY

IWN: iShares Russell 2000 Value ETF. The goal of this ETF is to track the investment results of the Russell 2000 Value Index. Current Stats: Management fee = 0.25%. Expense Ratio = 0.25%. Annual dividend = $1.97. Current yield = 1.93%.

VB: Vanguard Small-Cap Index Fund ETF Shares. The goal of this ETF is to track the performance of the CRSP U.S. Small Cap Index. Current Stats: Management fee = 0.06%. Expense ratio = 0.09%. Annual dividend = $.172. Current yield = 1.42%.

MID CAP EQUITY

VO: Vanguard Mid-Cap Index Fund ETF Shares. The goal of this ETF is to track the performance of the CRSP U.S. Mid Cap Index. Current Stats: Management fee = 0.07%. Expense ratio = 0.09%. Annual dividend = $1.60. Current yield = 1.26%.

LARGE CAP EQUITY

MGK: Vanguard Mega Cap Growth Index Fund ETF Shares. The goal of this ETF is to track the performance of the CRSP US Mega Cap Growth Index. Current Stats: Management fee = 0.08%. Expense ratio = 0.11%. Annual dividend = $1.05. Current yield = 1.27%.

VYM: Vanguard High Dividend Yield Index Fund ETF Shares. The goal of this ETF is to track the performance of the FTSE High Dividend Yield Index. Current Stats: Management fee = 0.07%. Expense ratio = 0.10%. Annual dividend = $1.97. Current yield = 2.91%.

VPU: Vanguard Utilities Index Fund ETF Shares. The goal of this ETF is to track the performance of the MSCI US Investable Market Index/Utilities 25/50. Current Stats: Management fee = 0.09%. Expense ratio = 0.12%. Annual dividend = $3.18. Current yield = 3.35%.

INTERNATIONAL EQUITY

VEA: Vanguard FTSE Developed Markets Index Fund ETF Shares. The goal of this ETF is to track the performance of the FTSE Developed ex North America Index. Current Stats: Management fee = 0.05%. Expense ratio = 0.09%. Annual dividend = $1.15. Current yield = 2.85%.

VWO: Vanguard FTSE Emerging Markets Index Fund ETF Shares. The goal of this ETF is to track the performance of a benchmark index that measures the investment return of stocks issued by companies located in emerging market countries. Current Stats: Management fee = 0.07%. Expense ratio = 0.15%. Annual dividend = $1.11. Current yield = 2.77%.

REAL ESTATE

VNQ: Vanguard REIT Index Fund ETF Shares. The goal of this ETF is to track the performance of the MSCI U.S. REIT Index. Current Stats: Management fee = 0.07%. Expense ratio = 0.10%. Annual dividend = $2.98. Current yield = 3.56%.

BONDS

BLV: Vanguard Long-Term Bond Index Fund ETF Shares. The goal of this ETF is to track the performance of the Barclays U.S. Long Government/Credit Float Adjusted Index. This index includes all medium and larger issues of U.S. government, investment-grade corporate, and investment-grade international dollar-denominated bonds that have maturities of greater than 10 years and are publicly issued. Current Stats: Management fee = 0.07%. Expense ratio = 0.10%. Annual dividend = $3.62. Current yield 3.79%.

TIP: iShares TIPS Bond ETF. The goal of this ETF is to track the performance of the Barclays U.S. Treasury Inflation Protected Securities Index (Series-L). Current Stats: Management fee = 0.20%. Expense ratio = 0.20%. Annual dividend = $1.86. Current yield = 1.7%.

Disclosure: The author is long IWN, VB, VO, MGK, VYM, VPU, VEA, VWO, VNQ, BLV.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.