In the search for the right mix of portfolio asset classes, it is tempting to overlook the obvious: the U.S. stock market. Alternative asset classes and exotic emerging markets may look appealing for investors seeking to diversify. But it does not pay to bet against America.
So far this year, the U.S. market has been beaten down by fears about slow global growth and the possibility of the Federal Reserve pushing rates higher. For years to come, however, the U.S. is likely to perform well. Keeping a primary, core position in a U.S. stock market exchange-traded index fund is a simple yet profitable investment strategy.
The U.S. is still number one
China, Russia, Brazil, and India are becoming economic heavyweights on the world stage. The new century brings the possibility that the U.S. will no longer be the largest economy in the world. But this macroeconomic story does not necessarily translate into a good investment idea.
Faster economic growth has not resulted in better investment returns. Rather, the U.S. has produced higher returns with less risk than emerging markets. The ten-year standard deviation of the U.S. market is 14.7 compared to 23.7 for emerging markets, according to Morningstar.
Emerging markets are plagued by intrusive governments that restrict free market forces and lack the rule of law that Americans take for granted. In addition, the U.S. excels at creativity and innovation. Rule of law, creativity, and free markets give the U.S. market an edge in the world economy that is likely to continue.
The U.S. is still the strongest economy and stock market in the world. A basic choice to focus on the domestic U.S. asset class rather than scattering across the globe in search of exotic alternatives helps form a solid foundation for your portfolio. Investing in the U.S. market is the most important asset allocation decision for investors to make.
Exchange-traded index funds are a good way to capture broad asset classes, such as the U.S. market. The Efficient Market Hypothesis maintains that the market is so efficient that current prices reflect all relevant information. Therefore, it is very difficult to outperform by picking individual stocks.
Buying the index rather than select stocks within the index is the winning strategy for most investors. Index funds run on autopilot, tracking a predetermined basket of stocks. Thus, index funds trade less frequently and are more tax efficient than traditional, actively managed funds operated by a high-cost stock picker.
The Vanguard S&P 500 ETF
In my opinion, Vanguard offers the best index funds in the marketplace. Vanguard is the market leader in the index fund space, with emphasis on low costs and ethics that put investor interests first. The Vanguard S&P 500 ETF (NYSEARCA:VOO) is the best choice for investors seeking to establish a core position in domestic U.S. stocks.
The S&P 500 Index is one of the most widely used proxies for the U.S. market. As the name suggests, it contains 500 stocks. The S&P 500 is broader than the Dow Jones Industrial Average, which contains only 30 stocks.
VOO is the lowest-cost ETF tracking the U.S. market, as far as I know, priced at 0.05% of assets per year. The fund industry average expense ratio is 1.02%, according to Vanguard. Accordingly, VOO is priced 95% lower than the fund industry average.
This cost advantage along with the difficulty of picking stocks help make index funds the winning choice. Very few professional fund managers or individual stock pickers - that includes most Seeking Alpha Contributors - can consistently outperform the S&P 500. In 2014, for example, it was reported that 85% of fund managers failed to outperform their benchmark indexes.
On the other hand
The U.S. economy and stock market are not perfect. The last ten years included an epic housing-market crash, the Great Recession, and a U.S. Government bailout of too big to fail Wall Street banks. Reckless politicians on Capitol Hill seriously contemplated a voluntary default on U.S. debt obligations, making the U.S. seem more like a high-risk emerging market than a developed one.
While it is wise to focus your asset allocation on the U.S. market, U.S. stocks should not be the only asset class in your portfolio. Asset-class diversification can help to improve long-term risk-adjusted returns. My point is that attempts to diversify away from U.S. stocks should not be overdone.
The Vanguard S&P 500 ETF is likely to outperform the vast majority of those who seek to pick individual stocks. But VOO cannot do better than the S&P 500 Index it seeks to track.
The bottom line
It pays to invest in America. The U.S. certainly has its fair share of problems. But the U.S. is still number one when it comes to the economy and financial markets. Buying and holding a broadly diversified U.S. stock market index fund such as VOO is a smart decision. The U.S. is the one asset class you can't do without.
Disclosure: I am/we are long VOO, VWO.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.