The 0.09% Fee, Two Fund Portfolio Every Investor Should Start With

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Includes: AGG, BND, BNDW, BNDX, IAGG, ITOT, IXUS, SPAB, SPDW, SPEM, SPTM, VT
by: Tariq Dennison
Summary

One academically tested way to invest is to start with a "global total market portfolio" of low-cost index funds.

An investor can now buy this "global total market portfolio" using only two funds / ETFs with a 9bps expense ratio.

From this starting point, investors can further adjust weights, factor exposure, or tax profile as needed to get a better, faster, and/or cheaper portfolio.

There is a saying in business that between good, fast, and cheap, you must choose two and can not have all three. When it comes to investing, I must thank competition between Vanguard and Blackrock Inc. (BLK) for giving us a very good mix of all three in our ETF choices that can be very hard to top.

The two fund, 0.09% fee world class portfolio

With Vanguard's fee cuts earlier this year, it is now possible for an investor to own a balanced portfolio of 98% of the world's stock and most of the world's bonds by value with just two funds:

  • Vanguard Total World Stock ETF (VT)
  • Vanguard Total World Bond ETF (BNDW)

These funds each have a 9 basis point expense ratio, meaning investors would pay fund expenses of only $900/year per $1,000,000 invested whether they allocated 80% to stocks and 20% to bonds or vice versa. This is about as simple as most investors should likely expect, since choosing the balance between stocks and bonds is perhaps the one factor too personal to successfully be covered by one ETF.

It is worth noting that BNDW is actually a fund of funds, which simply holds a 52% weight in the Vanguard Total International Bond ETF (BNDX) and 48% in the Vanguard Total Bond Market ETF (BND).

It is hard to argue that this portfolio ranks very highly as being good (earning returns matching top pension funds around the world), cheap, and fast (two trades to buy). This means a portfolio of these two ETFs should serve as a good initial benchmark or starting point for any other investment portfolio an investor might want to build differently.

The iShares Global Portfolio

Blackrock's iShares ETF brand, in addition to having one of the most user-friendly ETF websites, also has a lineup of ETFs that compete very closely with Vanguard on cost and coverage, in addition to having many extended market choices Vanguard does not offer. iShares's all-world stock index is not as broad at VT, but the closest competing portfolio of ~98% of the world's stocks and most of the world's bonds can be covered with the following four ETFs:

  • iShares Core S&P Total Market ETF (ITOT) - All US Stocks
  • iShares Core MSCI Total International Stock ETF (IXUS) - Non-US Stocks
  • iShares Core US Aggregate Bond ETF (AGG) - All US Bonds
  • iShares Core International Aggregate Bond ETF (IAGG) - Non-US Bonds

These have expense ratios of 3, 10, 5 and 9bp respectively, making it possible to have an expense ratio of even less than 9bp with these four funds depending on what percentage you would allocate to US vs non-US assets. An investor could do the same with Vanguard funds as well, where the US funds are cheaper than non-US funds.

What about State Street SPDRs or other ETF brands?

Rounding out the big three, I should also add the currently competing "global total market portfolio" using State Street's SPDR brand of low cost core "total market" ETFs:

  • SPDR Portfolio Total Stock Market ETF (SPTM) - US Stocks
  • SPDR Portfolio Developed World ex-US ETF (SPDW) - non-US Developed Market Stocks
  • SPDR Portfolio US Aggregate Bond ETF (SPAB) - US bonds
  • SPDR Portfolio Emerging Markets ETF (SPEM) - non-US Emerging Markets

A 3, 4, 4, and 11bps respectively, these ETFs can be the cheapest combination of core ETFs for investors who don't mind not excluding non-US bonds and/or underweighting emerging markets. The fact that these ETFs trade commission-free on Schwab is also why my 7-year built his ETF portfolio with these ETFs in his UTMA account.

Apologies to State Street if I've somehow missed a US listed USD-hedged total foreign bond market ETF, but I check both the US and UK sites for top ETFs several times a year, and I still haven't found a SPDR comp to BNDX or IAGG.

I also frequently check for ETFs from brands other than the big three, but have so far found they do not cover the global core quite as well, and are often better at certain niches, like frontier markets or factor exposure.

Why a non-US bond allocation is so important

Judging by fund assets, foreign bonds are probably the biggest asset category many investors underweight if not outright exclude from portfolios. Two major reasons to hold bonds are:

  • To preserve a fixed amount of capital and future income, and
  • To offset / diversify away from equity risk

The most obvious risk of investing in foreign bonds is currency risk. Fortunately, both BDNX/BNDW and IAGG hedge foreign bonds back into USD, enabling investors to diversify into foreign bonds at very low cost. This leaves the biggest advantage of owning foreign bonds: diversification away from rising US interest rates. If US interest rates rise and send US bond prices down, foreign rates may move differently, making a global bond portfolio significantly safer than an all-US bond portfolio. While US rates remain among the highest of the G7, and I don't expect any developed market will see rates above 3% anytime soon, this risk diversification is still important.

Why Deviate From This Simple Low Cost Portfolio?

Now that investors can buy a "global total market portfolio" for less than 10 basis points, why should any investor deviate from one of the above portfolios? While the most cynical reason I often hear is "advisor job security", there are a few real reasons why I find it worth to pay more for slightly more complex portfolios:

1. Taxes

While these broad, passive ETFs are already very tax-efficient for US taxable accounts (and not an issue for US retirement accounts), there are a few specific cases where tax efficiency can make more than 10-50bp of difference:

First, for US taxable investors, there are advantages in breaking down your holdings into many different non-overlapping funds or even single stocks for tax-loss harvesting purposes.

Second, many foreign investors face a withholding tax on dividends paid from the US which can be as high as around 30%. This especially hurts foreign investors buying US-listed foreign stock funds, since they pay the withholding tax of the foreign country to the US within the fund, then the withholding tax on the fund's dividend on top of that. For Hong Kong investors, the HKEX and EY have put together an ETF taxation report, to help decide when it might be better to buy non-US listed ETFs, or even buy foreign stocks directly.

2. Market Cap and Value Tilt

The second issue I have with these very simple portfolios is that they simply allocate more money to stocks and bonds that are "bigger", not necessarily those that are the "best" (quality), "cheapest" (value), or "fastest" (in terms of growth or momentum). I prefer to pay up to 20-30bp for a smart beta portfolio that incorporates these factors and/or gives me greater exposure to small cap stocks rather than accept buying too much of what might be overpriced. Two specific names I am not alone in thinking are overpriced are Tesla and Netflix, which I can avoid in value, small cap or single stock portfolios.

3. Exposure to Emerging Markets

A third, and perhaps most motivating, dissatisfaction I have with these "all world" portfolios is that they still overweight developed markets (especially the US), and underweight emerging markets (even China). VT, for example, allocates 55% to the US and less than 10% to emerging markets.

At many points in the cycle, including now, I believe many emerging markets (EM) not only have far better long-term growth prospects, but also far better valuations than developed markets, and so I prefer to add extra emerging markets exposure to portfolios.

Conclusion

For many investors, a super simple and super low cost "global total market portfolio" satisfies their core investment needs with little thought or effort. For advisors, this enables a choice between focusing on one of two things:

  1. Value adding with other services, like fee-only financial planning, or
  2. Weighing cost vs benefit of deviating from this portfolio for tax, factor, or country exposure reasons.

There are of course several other factors to consider, from motivations to want to own and understand individual companies to ESG and religious considerations, but these 2-4 funds still serve as an excellent starting point.

Tariq Dennison runs GFM Asset Management, a Hong Kong based US registered investment advisor. He is the author of the book "Invest Outside the Box: Understanding Different Asset Classes and Strategies"

Disclosure: I am/we are long VT, BNDW, BNDX, BND, ITOT, IXUS, AGG, IAGG, SPTM, SPDW, SPEM, SPAB. 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.