Is Simpler Always Better?

by: ETF Monkey

A quick thought for today.

Regular readers will know that, in general, I am in favor of relatively simple portfolios constructed with low-cost, quality ETFs.

I just completed building The ETF Monkey Millennial Model Portfolio for Seeking Alpha. This portfolio is comprised of 7 ETFs, covering U.S. stocks, foreign stocks, REITs and bonds.

I received this comment from a reader:

The proposed portfolio is overly complicated. Why don't you simplify the above to 90% VT + 10% AGG or 90% VTI + 10% AGG? Slicing and dicing may look cool. But it promotes more rebalancing which creates more trading and thus more costs.

While I am in favor of simple portfolios, there are on occasions valid reasons to use two (or three) ETFs when it could be argued that one would do.

Let me give a simple example from this portfolio. Instead of using the Vanguard FTSE All-World ex-US ETF (NYSEARCA:VEU) for the portion of the portfolio dedicated to foreign stocks, I used a combination of the Vanguard FTSE Developed Markets ETF (NYSEARCA:VEA) and the Vanguard FTSE Emerging Markets ETF (NYSEARCA:VWO).

In this case, I did it for two specific reasons. First, the ratio of emerging markets to developed markets is fixed in VEU. As shown here, it is 19.20%.

Since I was designing a portfolio for millennials, with a long time frame ahead of them and therefore a little higher tolerance for risk, I actually increased the relative allocation of emerging markets. Here are the asset allocations for the portfolio:

Look at the portion highlighted in green. You can see that, of the overall 35% allocated to foreign stocks, I allocated 8% of this to emerging markets. That's 22.86%, a little higher than the fixed allocation in VEU.

Additionally, developed and emerging markets don't always move in sync. By using 2 ETFs, I also have greater opportunities to rebalance the portfolio should there be a significant divergence in one of the asset classes.

Finally, the expense ratios are typically cheaper for developed market ETFs than emerging market ETFs. VEA comes in at .09%, VEU at .13% and VWO at .15%. If an investor wants to lean heavily in favor of developed foreign markets, with perhaps just a tiny allocation to emerging markets, this too can be a nice, albeit minor, benefit.

In summary, I like simple portfolios. But there are also times when breaking things down may offer desirable benefits.