This past February, based on a review of some investing wisdom from John C. Bogle and Peter L. Bernstein, I offered Seeking Alpha readers my take on the perfect portfolio for the next 10 years.
In combination, the two linked articles, one on my personal blog and one right here on Seeking Alpha, offer a thorough grounding in the argumentation offered by Mr. Bernstein in favor of a portfolio comprised of 60% stocks and 40% bonds, followed by a more recent recommendation from no less than John C. Bogle that, given the present environment, a 50/50 allocation may be even more prudent.
What, though, did I recommend as the 'perfect portfolio?' Here is how I summarized it in my Seeking Alpha article:
Without further ado, then, here is my "base" allocation for the next 10 years.
- 30% U.S. Stocks
- 20% Global ex-US Stocks
- 50% Long-Term U.S. Treasuries
In summary, we are talking about a 50/50 allocation in stocks vs. bonds, with the stock allocation being broken down 60/40 between U.S. stocks and foreign stocks.
In this article, we will look at suggestions to fill the allocation to U.S. stocks. I am going to take a look at the question of filling that allocation with large-cap stocks or the total U.S. market. In terms of large caps, we will select a world-class ETF which tracks the venerable S&P 500 index. As a contrast, we will select a world-class ETF which tracks the total U.S. market.
For general interest, before we are done, we will also take a quick peek at an intriguing 3rd option that I have seen recommended in other articles. Namely, an ETF which tracks the S&P 500 index, but equal-weighted as opposed to market cap-weighted.
Option One: The Venerable S&P 500 Index
The S&P 500 index holds a special place in stock market lore and history. It was created and is still maintained to this day by S&P Dow Jones Indices. S&P Dow Jones Indices publishes many stock market indices, but by far, the two most recognizable are the Dow Jones Industrial Average and the S&P 500 Index.
The S&P 500 is widely regarded as the most accurate gauge of the performance of large-cap American equities. While it focuses on the large-cap sector, it includes a significant portion of the total value of the market. It is perceived as more representative of the market than the Dow Jones Industrial Average because it is made up of 500 companies, compared to the DJIA's 30. Additionally, the S&P 500 uses a market cap methodology, giving a higher weighting to larger companies, whereas the DJIA uses a price weighting methodology which gives more expensive stocks a higher weighting.
The first ETF that may come to mind when you think of the S&P 500 is the SPDR S&P 500 ETF (SPY). Launched in 1993 by State Street Global Advisors, it is the very first ETF. In addition to this distinction, with a whopping $263.6 billion in AUM, it is also the world's largest ETF right down to this day. However, despite its venerable name and history, this ETF has some disadvantages when compared to others in this group. At .0945%, its expense ratio is 2x-3x that of the competing ETFs featured in this article. Further, because of its legal structure as a Unit Investment Trust, it cannot engage in securities lending and also cannot reinvest portfolio dividends generated between distributions.
For those reasons, my selection in this space is the iShares Core S&P 500 ETF (IVV). SPY will always hold the distinction of being the very first ETF. At the same time, IVV, with an inception date of May 15, 2000, also traces its history back to the very early days of ETFs. With respect to AUM, if you happened to click on the 'world's largest ETF' link found in the previous paragraph, you probably noticed that, at $160.9 billion, IVV sits in 2nd place. Along with Vanguard's S&P 500 ETF (VOO), it ties for a segment low expense ratio of .04%. This lower expense ratio results in a very slight outperformance compared to SPY.
- NOTE: While this article was being prepared, news broke that Vanguard just announced that VOO's expense ratio will be cut to .03%. However, as of this writing, the expense ratio still shows as .04% on VOO's web page.
Here, from the S&P 500 Index website, are the Top 10 holdings in the index.
Source: S&P 500 Index Website
Next, this graphic breaks out the sectors of the index.
Source: S&P 500 Index Website
In summary, IVV is a great choice if you wish to focus mainly on large-cap, established companies. In addition, since this fund very precisely tracks the S&P 500 average, when you get up in the morning and see how the S&P 500 index is doing, you will know exactly how 30% of the 'perfect portfolio' is performing that day.
Option Two: The Total U.S. Market
For this second option, my selection is the Vanguard Total Stock Market ETF (VTI). With an inception date of 5/24/2001, VTI has the distinction of being Vanguard's very first ETF. In the section above, I noted that IVV is the 2nd-largest ETF in the marketplace in terms of AUM. As it happens, with AUM of $108.0 billion, VTI slides nicely into 3rd place. With respect to expense ratio, in the same announcement referenced in the prior section, Vanguard announced that VTI's expense ratio, currently at .04%, would be cut to .03%.
As opposed to the S&P 500, which is comprised solely of large companies (large-cap), VTI tracks essentially the entire investable U.S. market in a single ETF. It does so by tracking the CRSP U.S. Total Market Index. As of this writing, Vanguard shows the index containing 3,590 companies. The smaller companies included in this broader index, while offering a higher level of risk than their larger brethren, also offer greater opportunities for growth.
Here, from the CRSP index website, is a look at the Top 10 stocks in the index.
Source: CRSP Index Fact Sheet
If you compare this list against that of IVV above, you will notice that the components are essentially the same, ignoring a slight difference in how they classify their Alphabet Inc. (NASDAQ:GOOGL) shares. However, they comprise a slightly smaller share of the overall pie, since VTI tracks a broader index.
Next, the sector allocations.
Source: CRSP Index Fact Sheet
Option Three: A Different Take On The S&P 500
For this last option, we will take a look at the Invesco S&P 500 Equal Weight ETF (RSP). This is the first time I have covered this ETF, but it has been featured in the model portfolios of other Seeking Alpha authors I have read.
With an inception date of 4/24/03, RSP has a long track record as a solid ETF. With AUM of approximately $15.2 billion and an expense ratio of .20%, RSP is both smaller and more expensive than either of our other two options.
As can be quickly gathered from the name, this ETF tracks the S&P 500 index, just like SPY or IVV, but with a key difference. Whereas the typical S&P 500 ETF is market-cap weighted, RSP is equally weighted. What does that mean?
Simply this. If you were to take a look at IVV's web page, you would find that the Top 10 holdings, added together, comprise 21.03% of the fund. In other words, roughly 1 of every 5 dollars invested in the fund is effectively in these 10 stocks, with the remaining 4 dollars allocated across the remaining 490.
In contrast, each of the 500 stocks holds a weighting of approximately .2% in RSP. Let's see how Invesco puts it in their "Funds in Focus" promotional document.
The Invesco S&P 500 Equal Weight ETF (RSP) is a smart beta exchange traded fund (ETF) that provides equal weight access to one of the most widely recognized indexes for US equities-the S&P 500. RSP offers a simple yet dynamic alternative to traditional core holding and cap-weighted strategies.
According to the same document, potential benefits include:
1. Outperformance potential versus the traditional cap-weighted approach
2. Reduced portfolio concentration risk resulting from a more balanced allocation
3. Quarterly rebalancing creates, as a byproduct over time, a buy low/sell high effect
4. Lower-cost, tax-efficient option vs. RSP's Lipper peer group
In an associated fact sheet, Invesco offers this great-looking graphic featuring RSP's performance over the past 10 years.
Source: Invesco RSP Fact Sheet
Playing It Out in the Portfolio
Similar to the previous article in which I suggested ETFs with which to implement the bond allocation in the 'perfect portfolio,' I have offered 3 ETFs worthy of your consideration for the allocation related to U.S. stocks.
Again, similar to that preceding article, I present the results of a backtest on Portfolio Visualizer. To try to get some idea of how each of these ETFs might play out when paired with long-term U.S. Treasuries, I built 3 iterations starting with 50% of each of our 3 ETFs, with the remaining 50% covered by TLT.
The portfolio covers the period from January 2004 to the present (the starting point was limited by the inception date of RSP). The portfolio was rebalanced annually and all dividends were reinvested. Please note that I did not include any representation for foreign stocks, which are included as part of the 'perfect portfolio.' I will cover ETFs for that allocation in a future article. For now, though, I wanted to offer you a simple, uncluttered view into how each of our 3 options for U.S. stocks pairs up with TLT.
First of all, here are the allocations for the 3 iterations.
Source: Portfolio Visualizer Comparison
Next, the results.
I find the results of this backtest quite interesting. Of the 3 variants, over this roughly 15-year period, the one that includes RSP comes out the winner. At the same time, you will notice that RSP introduces a modestly greater amount of volatility into the mix.
Finally, if you go back and take one more look at that Invesco promotional graphic, you will see that RSP's rather substantial outperformance has been fairly consistent since roughly the market bottom in March, 2009.
With that in mind, however, you might find this next graphic of interest. Here's a quick look at an RSP vs. IVV comparison for the period 2003-2009.
Perhaps you quickly spotted the eerie similarity between the period of 2003 through approximately mid-2007, and the Invesco picture above. But then, how does it look from that point to the trough in 2009? Given where we sit right at this point in time, could that pattern repeat? Certainly, it is something to think about.
Some Final Thoughts
Building on my work in search of the 'perfect portfolio,' I have offered 3 ETFs with which to build the portion devoted to U.S. Stocks.
As I consider the Portfolio Visualizer comparison above, I find myself personally leaning in favor of sticking with either IVV or VTI. You may have a shot at slightly higher returns with RSP, but it would appear you are accepting greater volatility. And then, there's that nagging question with which I ended the last section. Finally, here's one last consideration. If income is important to you, IVV is the best of the bunch.
As I alluded to a little earlier in the article, I hope to return soon with an article offering suggested ETFs for the international portion of the portfolio. I may also have a couple of intriguing wrinkles for you to ponder.
In the meantime, as always, I wish you...
Disclosure: I am/we are long VTI. 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.
Additional disclosure: I am not a registered investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes, and to consult with their personal tax or financial advisors as to its applicability to their circumstances. Investing involves risk, including the loss of principal.