Update: ETF Focus Ultra Low Cost Core Portfolio (Year-End Trades And Rebalancing)

by: Dave Dierking, CFA

It's time to review the ETF Focus Ultra Low Cost Core Portfolio, take a quick look back at 2018 and, more importantly, look forward to 2019.

The Ultra Low Cost Core Portfolio is one of seven model portfolios currently available to ETF Focus subscribers.

This portfolio aims to provide a typical long-term asset allocation using only the cheapest ETFs available among domestic and international stocks and bonds.

Ultra Low Cost Core beat its benchmark by 3.5% in 2018. Five of the portfolio's nine components will be changed in 2019.

The ETF Focus Ultra Low Cost Core Portfolio was the first of our model portfolios and aims to achieve a very simple goal - offer a broadly diversified portfolio that keeps costs as low as possible. It's a balanced portfolio that maintains a 75/25 mix of stocks and bonds but really can be tweaked for whatever allocation you wish. The funds used in this portfolios are among the cheapest you'll find in their respective categories with the expense ratio on the portfolio as a whole coming in at just over 6 basis points.

For investors looking for a simple and straightforward long-term buy and hold portfolio, this will be ideal. Is it perfect? Of course not. There are pockets of the markets that are missing, while those living off of their portfolio income likely won't be very impressed by its 2.3% yield. But if you've got a long time horizon or are just looking for a "set it and forget it" portfolio, this will work very well.

Like most portfolios that use an allocation balanced between U.S. stocks, foreign stocks, and bonds, the original target allocations have gotten a little out of whack. As is the case with all of the ETF Focus model portfolios, I made a hypothetical $100,000 investment in this portfolio at the start of 2018. All dividends accrued are reinvested.

Changes For 2019

As should be the case with any year-end portfolio review, I reexamined every component of the Ultra Low Cost Core Portfolio and made a few changes. Of the portfolio's nine components in total, five will be new in 2019. The changes are highlighted below before I get into each one individually and why I made the change.

It's important to remember here that despite more than half of the portfolio's components being changed, it's not being overhauled in any noticeable way. These are all broad vanilla low-cost index ETFs whose composition is substantially similar to the funds that they're replacing. But there are opportunities for improvement out there whether it's a slight cost savings, better diversification or better fit with other funds in the portfolio. Also, keep in mind that these changes aren't being made to chase performance or increase yield or anything like that. They're being made to improve the overall fit and composition of the portfolio as a whole.

  • Out: Vanguard S&P 500 ETF (VOO)
  • In: Vanguard Mega Cap ETF (MGC)

Why: The Vanguard S&P 500 ETF (or any of the S&P 500 ETFs) makes a perfectly fine large-cap portfolio holding, but in the case of Ultra Low Cost Core, some of the holdings were overlapping with our mid-cap ETF. The percentage of overlapping assets between VOO and the Schwab U.S. Mid Cap ETF (SCHM) was 4%, but some mid-cap ETFs, depending on how they define mid-cap, can be around 15%. It makes more sense to use ETFs that we know don't overlap with each other.

As you'll see in a little bit, I'm replacing the portfolio's large-cap, mid-cap and small-cap ETFs with three offerings from Vanguard. I'll be going instead with the Vanguard Mega Cap ETF, the Vanguard Mid Cap ETF (VO), and the Vanguard Small Cap ETF (VB). Why am I choosing MGC instead of the Vanguard Large Cap ETF (VV)? The answer is that VV is actually a combination of holdings from MGC and VO. They're not mutually exclusive. MGC covers the companies responsible for the top 70% of total market cap, VO covers the 70-85% range and VB covers 85-98%. VV covers the 0-85% range, so it's actually just a simple combination of MGC and VO.

If you wanted a bit more simplicity, you could buy VV/VB and get the exact same coverage as MGC/VO/VB. Or if you wanted everything all in one product, just go with the Vanguard Total Stock Market ETF (VTI).

  • Out: Schwab U.S. Mid Cap ETF
  • In: Vanguard Mid Cap ETF

Why: We're taking out SCHM in favor of VO for the reasons already mentioned, but putting the two side-by-side is a good reminder about how not all funds that sound the same actually are. In fact, just 30% of assets overlap between the two ETFs.

We already mentioned how VO is built using a market-cap band. SCHM's index simply grabs the companies that are ranked 501-1000 by market cap. In that sense, SCHM fits with well with an S&P 500 fund that, for the most part, just takes the 500 largest companies. It's a seemingly innocuous detail that actually makes for a big difference in their compositions.

  • Out: iShares Core S&P Small Cap ETF (IJR)
  • In: Vanguard Small Cap ETF

Why: Same reasons as above.

  • Out: iShares Core MSCI EAFE ETF (IEFA)
  • In: Schwab International Equity ETF (SCHF)

Why: SCHF has three things going for it that made me give it the slight edge over IEFA. First is the fact that it's cheaper. SCHF's 0.06% expense ratio is slightly lower than the 0.08% number from IEFA. In a portfolio that targets the lowest costs possible, that matters! Second is the fact that SCHF includes South Korea whereas IEFA doesn't. IEFA's index considers South Korea as an emerging market, not a developed one. I personally think that South Korea is closer to a developed market than an emerging one, so it's inclusion here is more appropriate. Since our emerging markets ETF, the SPDR Portfolio Emerging Markets ETF (SPEM), doesn't include South Korea, it makes sense to pair the two up. Third is the fact that SCHF includes Canada, where IEFA doesn't. Again, Canada is often omitted from EAFE indices since it's in North America, but SCHF makes the right call to include it.

  • Out: iShares Core U.S. Aggregate Bond ETF (AGG)
  • In: iShares Core Total USD Bond Market ETF (IUSB)

Why: AGG is the fixed income benchmark of choice for many, but I dedicated an entire article earlier this year to why I think IUSB is a better bond benchmark. In short, IUSB is more diversified since it includes both junk bonds and international bonds in its portfolio and is slightly less risky than AGG despite holding a higher percentage of assets in corporate bonds. One of the ancillary side benefits of holding IUSB is that since it has slightly more invested in corporate bonds, it also has a slightly higher yield. IUSB charges 0.01% more than AGG, but the tradeoff seems well worth it.

Year-End Rebalancing

To complete the year-end rebalance on the portfolio, I first made the five trades listed above as of December 31st. Once the new positions were established, I completed the rebalancing transactions. That'll be the reason why you'll see two transactions in the transaction log for some of the ETFs.

The graphic below details all transaction activity that took place on December 31st. The "Starting Share Balance" column is what the portfolio looked like coming into the day. The "Intermediate Share Balance" column shows the portfolio after the transactions listed above. The "Ending Share Balance" shows what the portfolio looks like after the trades and rebalancing transactions. The total dollar value of the portfolio, obviously, remains the same post-rebalance.

Most of the positions just required small tweaks. 2018 underperforms, including small-caps, mid-caps, and foreign equities were added to, while fixed income and large-cap positions were reduced.

These moves bring us back almost exactly to our original target asset allocation.


For the full year 2018, the Ultra Low Cost Core Portfolio was down 5.64%. That tops the -9.13% return of the portfolio's benchmark, a mix of 75% S&P Global BMI Index and 25% Barclays Global Aggregate Bond Index, and the S&P 500's total return of -6.24%.

The top-performing holdings were all three fixed-income holdings. The iShares Core International Aggregate Bond ETF (IAGG) was the biggest winner returning 3.38%. This is an asset class that has always felt unloved to me. The monthly dividend payments can carry some inconsistency and the yields often times aren't on par with what you can earn in domestic fixed income products. But some areas of the market, particularly emerging markets debt, are starting to look a little more attractive. Even IAGG, which historically has had a yield under 2%, has a trailing 12-month dividend yield of over 3%.

Foreign equity ETFs were the year's biggest drag on the portfolio. The SPDR Portfolio Emerging Markets ETF and the iShares Core MSCI EAFE ETF were both down more than 13% last year. All of our equity ETF positions were in the red with the Vanguard S&P 500 ETF and the Fidelity MSCI Real Estate ETF (FREL) holding up best (down 4.5% each).

Dividend Income

The Ultra Low Cost Core Portfolio paid a total of $2,297.48 in dividend income in 2018 translating to a dividend yield of around 2.3%.

Based on current 30-day yields for each component, Ultra Low Cost Core is still right at 2.3% as we kick off the year. I'd expect that dividend income for 2019 might come in slightly above that number as corporate bond yields as well as the yields on both foreign equities and bonds have begun ticking up. A yield of around 2.5% could be a more reasonable estimate.

Asset Allocation

The year-end rebalance pulls things back towards their original allocations. North America gets trimmed back from 76.3% last quarter to 73.9% today. Emerging markets go from 7.2% to about 8.4%. Foreign developed markets see a minor increase in assets, while others see only relatively minor tweaks.

The rebalance also shifts what was 58/18 split between domestic and foreign stocks back to a more reasonable 55/20. It also, however, lifted the percentage of assets in large-caps from 64% to 74%. The lower allocation to mid- and small-caps might not be bad if the markets pull back in 2019, but this was a larger jump than I was anticipating. I may need to do a little more work on this one to figure out where exactly the big jump came from (I suspect it's coming from SCHF and SPEM, but I'd need to confirm).

The biggest change on the fixed income side is that 39% figure that dropped from the moderate/high-quality group to the moderate/medium quality group. That's thanks to the switch from AGG to IUSB. AGG is more than 2/3 in government bonds, whereas IUSB comes with higher allocations to high yield and BBB-rated bonds. Risk-wise, there's not a lot of difference between the two.


While November's modest rebound allowed us to post some gains, The 4th quarter overall was a tough one. Ultra Low Cost Core posted a loss of 10%, right on par with its benchmark, although the 60/40 allocation helped cushion against some downside loss in the volatile environment.

Note: The dark skinny line on the chart is for a benchmark index for the broad U.S. stock market that is not comparable to this portfolio. Unfortunately, Morningstar wouldn't let me remove it from the chart. The green line/bar is what's important here.

Breaking down that -5.6% total return figure, the portfolio posted a 2.3% gain from dividend income to go along with a -7.9% capital loss. Overall, I'm pleased with how the portfolio performed and, for the most part, it did what it was intended to do - reduce volatility, protect against downside losses while delivering appropriate risk-adjusted returns. The international stock ETFs were obviously a drag on performance, but the 40% allocation to fixed income suddenly became more attractive as volatility picked up and the Fed gave indications that they were going to hold off on future rate hikes.


I expect another relatively volatile ride in 2019 although the VIX has slowly cooled down to its lowest levels in about the last three months. The Fed, trade, GDP growth, and Brexit are all factors that will keep investors on their toes. Valuation may finally come back into play as investors seek out bargains instead of growth for above-average returns.

The foreign developed and emerging markets appear to be more attractively valued than the United States and could finally be a source of excess returns this year. The portfolio's fixed income positions, which looked like they could be headed for a year in the red as the Fed continued hiking rates, now look like they could post gains again. Rates dropped significantly towards the end of the year and the 10-year Treasury could move back towards 2.5% if GDP comes in weak and corporate earnings growth slows.

In my "6 Top ETF Picks For 2019" article, I made the case why the iShares 10-20 Year Treasury Bond ETF (TLH) could be in line for a 4-5% total return in 2019 if rates begin pulling back. That doesn't sound like a number to get really excited about, but it could look comparatively solid if equities again struggle to stay out of the red.

Within this portfolio, I'm bullish on SPEM, FREL, IUSB, and VTIP, while remaining skeptical of MGC and VB. Equities overall have enjoyed a nice pop to kick off the year, but is the bottom really in on this unusually short bear market already? History suggests that the answer is no and the recent bottom could be retested in time. Ultra Low Cost Core's focus on high-quality ETFs at rock bottom costs could be a good to approach the new year cautiously.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.