ETFs Made Easy: 2 Simple Portfolios

February 12, 2015

Question 3: Do You Want More Complexity?

There are plenty of things wrong with the simplistic two-ETF portfolio above. Off the bat, it’s not actually the very cheapest you could do.

If you’re a Schwab customer, you could replace AGG with the Schwab U.S. Aggregate Bond ETF (SCHZ | A-99) and save 0.02 percent and not pay to trade, at the expense of a little long term tracking difference.

If you’re a Vanguard customer, you could pay the same fee to get the Vanguard Bond ETF (BND | A-94) to get free trades at the expense of a little long-term tracking difference. Those are legitimate concerns, but if we’re being honest, that's fairly fine hair-splitting.

The biggest issue with this two-ETF portfolio is precisely its simplicity.

There are, for instance, no international bonds in it. If we were going for maximum diversification, we’d reach for some international exposure, either by replacing the venerable AGG with the newly launched iShares Core Total USD Bond Market ETF (IUSB | C), which adds dollar-denominated international bonds to a U.S. base, or by splitting the bond bucket in two to wedge in an international bond ETF like the Vanguard Total International Bond (BNDX | B-57). That would get us broad international exposure without taking on currency risk.

And we could do the same thing with our equity position. VT is a fine, fine fund, but because it’s market cap weighted, it’s still 51 percent in U.S. stocks, and overall, its 93 percent in developed markets. Less than 8 percent of the fund is in small or microcap stocks.

There’s nothing wrong with those allocations—it’s the market weight. But if this is the “risky” part of our portfolio, we could certainly split the exposures into U.S. equities, developed international equity (without euro and yen risk) and emerging markets.

 

And all of the sudden, our “simple” portfolio looks like something like this:

Fund Ticker Allocation Expense Ratio
Vanguard Total Stock Market VTI 40% 0.05%
Deutsche X-Trackers MSCI EAFDE Hedged Equity DBEF 10% 0.35%
iShares Core MSCI Emerging Markets IEMG 10% 0.18%
iShares Core U.S. Aggregate Bond AGG 30% 0.08%
Vanguard International Bond BNDX 10% 0.20%
    Blended ER 0.16.9%

Again, there are easy tweaks to make here depending on where you hold your assets and your sensitivity to fees and commissions.

As a Schwab customer, you might swap out the equity positions for the nearest Schwab equivalents, the Schwab US Broad Market ETF (SCHB | A-100), the Schwab International Equity ETF (SCHF | A-95) and the Schwab Emerging Markets Equity ETF (SCHE | B-82).

As a Vanguard customer, you might reach for the Vanguard Emerging Markets (VWO | C-82) over the iShares offering. Heck, if you’re a believer in active management, you could just swap the whole bond position for Fidelity’s new Fidelity Total Bond ETF (FBND).

Regardless, it’s easy to see how a simple idea can get complicated pretty quickly. We’re still in the simplest of ideas here—we haven’t added any new asset classes. We’re not looking at REITs or gold or commodities or liquid alternatives. We’re not even trying to make any guesses about growth or value or small-caps or individual sectors or countries. And this portfolio of just five ETFs will require more frequent rebalancing, as something in it will always be the winner, while something else is the loser.

Keeping It Simple

Part of the joy in investing is actually embracing complexity—it’s what makes investing actually fun for some people. But that doesn’t mean it’s smart. Most investors—myself included—are better off the simpler we keep things.

With more than 1,600 ETFs to choose from, it can be a bit overwhelming trying to choose the best ETF for any given purpose. But by keeping the exposures broad and looking at a few key quality measures (such as ETF.com’s scores and analysts picks), you can make informed decisions without having to crack open your MBA textbooks.


At the time this article was written, the author held positions in SCHE, SCHB, SCHF and DBEF. You can reach Dave Nadig at [email protected], or on Twitter @DaveNadig.

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