Vanguard ETF Portfolio For The Moderate Investor

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Includes: BND, BNDX, VBTLX, VEXAX, VFIAX, VOO, VTABX, VTIAX, VXF, VXUS
by: Tom Vaughan

Summary

Exact recommended allocation for a low-cost Vanguard Index Moderate Growth portfolio.

Historical performance for the portfolio versus the S&P 500 Index.

Globally balanced portfolio.

Vanguard ETF and Vanguard Index Funds - Moderate Growth Portfolio

This Vanguard Moderate Growth Portfolio was created for the investor looking for a balance of stocks and bonds that provides a moderate amount of growth with less-than-average market risk.

This portfolio has experienced shallow downturns and quick recoveries, allowing the cautious investor to sleep well at night. Incredibly, this portfolio has a slightly higher return than the S&P 500 Index since January 1999. This was all achieved using the lowest-cost Vanguard ETFs or Vanguard Index Funds, which allowed a majority of the return to be passed on to the investor. See "How to Make an Investment Portfolio: 6 Steps to Better Investing" for a full understanding of how to make the best index portfolio.

This pie-chart shows the exact allocation I recommend if you are trying to make a growth portfolio using Vanguard ETFs or Vanguard Index Funds.

Disclosure: I own this portfolio

This portfolio was created using the Black-Litterman method of efficient frontier portfolio creation. I carefully selected low-cost Vanguard ETFs that work well together. To perform a long-term analysis (since Jan '99), I found all of the matching Vanguard Index Funds. The only exception was using Citigroup Non-USD WorldBIG Index (currency hedged) to represent the Vanguard Total International Bond ETF (NASDAQ:BNDX). I then created a portfolio that represents the current world allocation representing these categories.

Using the Zephyr AllocationADVISOR software, I targeted a portfolio that historically has roughly 40% (.40 beta) of the risk of the S&P 500 Index. The Vanguard portfolio that you see above is the result of this methodology. Read "How to Create Your Ideal Diversified Investment Portfolio" to fully understand the concepts behind this portfolio design.

Here is a description of the best Vanguard Funds to use for this portfolio:

Vanguard S&P 500 ETF (NYSEARCA:VOO) or Vanguard Five Hundred Index Fund (MUTF:VFIAX) - This fund buys the 500 stocks selected by S&P to represent the U.S. large cap stock universe. It has the advantage of being an index that is recognized and purchased around the world. A limited number of stocks with growing global demand and an incredibly low 0.05% expense ratio make this a good core holding for your portfolio.

Vanguard Extended Market Index ETF (NYSEARCA:VXF) or Vanguard Extended Market Index Fund (MUTF:VEXAX) - This fund contains all of the U.S. common stocks regularly traded on the New York Stock Exchange and the NASDAQ over-the-counter market, except those stocks included in the S&P 500 Index. This fund fills in the blanks that are missing from the S&P 500 Index. It holds a total of 3,078 U.S. stocks, mostly mid and small caps, which gives you fantastic coverage of the U.S. stock market.

Vanguard Total International Stock ETF (NASDAQ:VXUS) or Vanguard Total Intl Stock Idx Fund (MUTF:VTIAX) - This fund tracks the market-cap weighted FTSE Global All Cap ex US Index, which covers 99% of the world's global market capitalization outside the U.S. The ETF holds 5,512 stocks from 46 developed and emerging markets.

Vanguard Total Bond Market ETF (NASDAQ:BND) or Vanguard Total Bond Market Index Fund (MUTF:VBTLX) - This fund is designed to give a broad-based exposure to most U.S. bonds with an amazing 6,979 different bonds. I use this fund when my efficient frontier allocation calls for mortgage-backed assets as well as the three bond funds listed above, which happens in two of my six portfolios. It is better to purchase one fund instead of four. However, I do not use it across all models, because I want more short-term bonds in my conservative portfolios and more long-term bonds to hedge my more aggressive portfolios.

Vanguard Total International Bond ETF (BNDX) or Vanguard Total International Bond Index Fund (MUTF:VTABX) - This fund tracks the Barclays Global Aggregate ex-USD Float Adjusted RIC Capped Index (USD Hedged). The Index includes government, government agency, corporate, and securitized non-U.S. investment-grade fixed income investments. They are all issued in currencies other than the U.S. dollar, with maturities of more than one year. To minimize the currency risk, the ETF will attempt to hedge its currency exposures. The ETF currently holds 2,246 bonds.

Incredible diversification - Just five ETFs and you will own 9,090 stocks and 9,225 bonds. This is a total of 18,315 holdings that you can buy for the cost of five ETFs, which are free to purchase if you use a Vanguard Brokerage account.

These next two charts show the historical performance of my Vanguard Moderate Growth Portfolio versus the S&P 500 Index. I like to compare all of my portfolios to the S&P 500 Index for comparison consistency. Keep in mind that this is not meant to be an apples-to-apples comparison, as the S&P 500 Index and my Vanguard Moderate Growth Portfolio are quite different, but you may find this comparison educational.

Source: Zephyr StyleADVISORTM*

Source: Zephyr StyleADVISORTM*

You can see how relatively stable this portfolio has been in the first chart. Since January 1999, the portfolio gained on the market during downturns due to the stabilizing effect of the bond holdings, but it gives back some of those gains during the better stock markets. That is the primary purpose of this type of portfolio - to provide decent returns without the full risk of the market.

It is very important to keep the internal costs of your portfolio low. This chart shows the expense ratio for this Vanguard Moderate Growth Portfolio versus the average Managed Mutual Fund, Index Fund, and ETF.

Source: Morningstar*

As you can see with an expense ratio of only 0.13%, this Vanguard ETF Portfolio is significantly cheaper than the average portfolio investment. I have found in my studies that, over the long-term, portfolios with lower cost significantly outperform portfolios with high cost. These lower-cost portfolios often outperform by more than just the differences between their expense ratios. It seems that investment companies that are willing to charge you a high expense ratio are also willing to charge you more in other areas as well, and they are unable to make up the difference with superior investing choices.

This chart shows the dividend yield paid over the last 12 months for the Vanguard Moderate Growth Portfolio versus the S&P 500 Index.

Source: Morningstar*

Due to the low interest rates on bonds and the conservative nature of the portfolio, the portfolio produces a dividend of 1.43%. When interest rates go up, this payout will go up, but it may lead to more volatility for the bond portion of the portfolio.

This next chart shows the largest drawdown since January 1999 for this Vanguard Moderate Growth Portfolio versus the S&P 500 Index.

Source: Zephyr StyleADVISORTM*

We have had some really bad stock market downturns since January of 1999, but this Vanguard ETF portfolio's worst fall was only -17.4%. Although it's worth being cautious when looking at worst case scenarios for portfolios that have a lot of bonds, we have not had any really bad bond markets since January 1999. To find bad bond markets, you need to go back further.

This next chart shows the drawdowns for the Morningstar Intermediate-Term Bond Index since 1954:

Source: Zephyr StyleADVISORTM

This bond drawdown chart shows the relative stability we have had in bonds since 1999 compared to earlier time periods. Take note of the 26% drop in the early 1970s. We may never see another collapse in the bond market like this again, but it is important to fully understand the possible risk of any portfolio mixture.

It is important to consider and understand the risk of bonds in your portfolio, but it is more important to remember that 40% of this portfolio is invested in the much riskier stock market. It may or may not be a good time to invest in longer-term bonds, but shortening maturities of the bonds in this portfolio may actually increase the risk if the stock market falls again. I am nervous about the bond market, but I am always more nervous about the stock market. I try not assume I know what is going to happen next and just create well-diversified portfolios that target certain risk levels.

It is one thing to have your portfolio fall, it is another to have to wait a really long time for it to come back. This next chart shows how long the portfolio fell and how long it took to recover:

Source: Zephyr StyleADVISORTM*

During the Financial Crisis Meltdown of 2008, both the Vanguard Moderate Growth Portfolio and the S&P 500 Index fell from their high point for 16 months, but due to a better overall balance and conservative nature, the Moderate Portfolio was able to recover back to the high point in only nine months, which was 28 months faster than the S&P 500 Index. Read "Best Method to Evaluate Investment Risk" to see more details about my series of risk tolerance tests you can take to find your personal risk tolerance.

*In order to present a longer historical track record, the data for all of the above charts was derived from the relevant Vanguard Index Funds that are part of the Income with Moderate Growth Portfolio. Vanguard Index Funds are almost exactly the same as their Vanguard ETF counterparts. The only exception was using Citigroup Non-USD WorldBIG Index (currency hedged) to represent the Vanguard Total International Bond ETF. The portfolio was rebalanced on an annual basis. You cannot actually buy the S&P 500 Index - only an investment that replicates this index. This is for demonstration purposes only as the past does not guarantee future performance.

Disclosure: The author is long BND, BNDX, VOO, VXF, VXUS.

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