These 5 simple rules will help you build the right asset mix and avoid a hodgepodge that won't achieve your retirement goals.
Despite what many Wall Street firms and advisers may suggest, you don’t need to stock your portfolio with an ever-expanding array of funds and ETFs to navigate today’s global financial markets. In fact, such a portfolio may do more harm than good. Here’s how to tell whether you’re diversifying or di-worse-ifying.
It doesn’t take a lot to reap the benefits of diversification. Over the 20 years to the end of June, for example, a simple mix of 55% U.S. stocks, 10% foreign developed-country shares, 5% emerging markets stocks and 30% U.S. bonds gained an annualized 8.7%, and lost roughly 27% in the crash year of 2008, according to Morningstar. Had you broadened that portfolio to include international bonds, REITs, commodities and hedge funds, it would have returned 8.6% and lost about 25% in 2008. Basically a wash.
The results could be different over other periods. But the point is that once you own a diversified blend of low-cost funds or ETFs that include U.S. stocks and bonds and foreign shares, you should think long and hard before taking on more investments.
Unfortunately, many investors can’t seem to resist loading up on every Next Big Thing investment that comes along. How can you tell whether your portfolio is an example of prudent diversification or imprudent di-worse-ification? Answer these five questions:
1. Do you need the fingers of both hands to count your investments? There’s no official “correct” number of investments you should own. But once you get beyond five or six, chances are you’ve got a lot of overlap or you’re venturing into arcane investments you don’t need. Truth is, you can get pretty much all the domestic and foreign diversification you need with just three index funds: a total U.S. stock market fund, a total U.S. bond market fund and a total international stock fund. You can see whether you suffer from “investment overlap”—i.e., you own the same securities multiple times in different investments—by going to the Portfolio Manager tool in RealDealRetirement’s Retirement Toolbox.
2. Do you own investments you don’t really understand? I don’t mean having a vague understanding, as in “Oh yes, it’s a leveraged ETF that gives you twice the return of the S&P 500,” or “I own a variable annuity that returns a guaranteed 7% a year.” I’m talking about really knowing how that leveraged return is calculated (which has big implications for what it will return) and what that 7% guarantee is actually being applied to. If you don’t know how an investment actually works, then you can’t know whether you truly need it.
3. Can you explain exactly why you bought each investment you own? Because it was mentioned on a cable TV investment program or appeared on some publication’s Top 10 list isn’t an acceptable answer. In addition to knowing how an investment works, you need to understand what specific role it plays in your portfolio and how, precisely, it improves your portfolio’s performance. Ideally, you should also be able to quantify the benefit you receive from owning it by citing research or pointing to performance figures that demonstrate how it enhances the tradeoff between risk and return.
4. Do you own investments that you’ve never touched after buying? If you’re following a long-term investing strategy, then the mix of assets in your portfolio—50% in large-company stocks, 10% in small, 40% in bonds, whatever—should reflect your investment goals and risk tolerance. As different investments earn different returns, you must periodically rebalance your portfolio to restore it to its proper proportions. To do that, you sell some shares of the winners and plow the proceeds into laggards and/or put new cash into investments that earned lower returns. But if you have investments you’ve never pulled money from or added money to, that suggests they’re not part of this rebalancing process, and thus not really an integral part of your investing strategy.
5. Do you regularly add new investments to your portfolio? If you do, you’re probably di-worse-ifying. Once you’ve created a well-balanced portfolio, your investing work is pretty much finished. Sure, there’s monitoring and rebalancing, and maybe jettisoning the occasional dud and replacing it with a new version of the same investment (a situation you can largely avoid if you stick to index funds). But you don’t need to constantly add new asset classes or investments just because investment firms keep bringing them out. In fact, if you do, you’re more likely to end up with an unwieldy hodgepodge of investments that’s difficult to manage rather than a simpler portfolio that more efficiently balances risk and return.
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More and more 401(k)s offer a formerly rare option—a brokerage window. That's raising questions from Washington regulators. Here's what you should watch out for.
While 401(k)s are known for their limited menu of options, more and more plans have been adding an escape hatch—or more precisely, a window. Known as a “brokerage window,” this plan feature gives you access to a brokerage account, which allows you to invest in wide variety of funds that aren’t part of of your plan’s regular menu. Some 401(k)s also allow you to trade stocks and exchange-traded funds, including those that target exotic assets such as real estate.
No question, brokerage windows can be a useful tool for some investors. But these windows carry extra costs, and given the increased investing options, you also face a higher risk that you’ll end up with a bad investment. All of which raises concerns that many employees may not fully understand what they’re getting into with these accounts. Earlier this week the U.S. Labor Department, which has been fighting a long-running battle to make retirement plans cheaper and safer for investors, asked 401(k) plan providers for information about brokerage windows.
You may wonder if a brokerage window is something you should use in your 401(k). To help you decide, here are answers to three key questions:
How common are brokerage windows?
Not long ago these features were rare. As recently as 2003, just 14% of large plans included offered a brokerage window, according to benefits company Aon Hewitt. But they’ve grown steadily more popular over the past decade, with about 40% of plans offering this option as of 2013. Interestingly, the growth has taken place even as more 401(k)s have opted to take investment decisions out of workers’ hands by automatically enrolling them in all-in-one investments like target-date funds.
Those two trends aren’t necessarily at odds. Experts say companies often add brokerage windows in response to a small but vocal minority of investors, who, rightly or wrongly, believe they can boost returns by actively picking investments. But overall just 5.6% of 401(k) investors opt for a window when it is offered. The group that is most likely use a brokerage window: males earning more than $100,000, about 9% of whom take advantage of the feature, according to Hewitt. (Not surprisingly, this group also tends to have the corporate clout to persuade HR to provide this option.) By contrast, only about 4% of high-earning women use a window.
When can brokerage windows make sense for the rest of us?
That depends in part on whether the other offerings in your 401(k) meet your needs. If you want an all-index portfolio, for example, a brokerage window may come in handy. Granted, more plans have added low-cost index funds, especially if you work for a large or mid-sized company. Today about 95% of large employers offer a large-company stock index fund, such as one that tracks the S&P 500, according to Hewitt.
Workers at small companies are less likely to enjoy the same access, however. These index funds are on the menu only about 65% of the time in plans with fewer than 50 participants, according to the Plan Sponsor Council of America, a trade group.
Moreover, even in large plans investors seeking to diversify beyond the broad stock and bond market can find themselves out of luck. Only about 25% of plans offer a fund that invests in REITS. And only about two in five offer a specialty bond fund, such as one that holds TIPS.
But even if a window allows you to diversify, you need to consider the additional costs. About 60% of plans that offer a brokerage window charge an annual maintenance fee for using it, according to Hewitt. The average amount of the fee was $94. And investors who use the window typically also pay trading commissions, just like they do at a regular brokerage.
Where does that leave me?
Before you decide to opt for a brokerage window, check to see if the fees outweigh the potential benefits. Here are some back-of-the-envelope calculations to get you started:
If you have, say, $200,000 socked away for retirement, paying an extra $100 a year to access a brokerage window works out to a modest additional fee of 0.05%. While the brokerage commission would increase that somewhat, you can minimize the damage by trading just once a quarter or once a year.
If your plan includes only actively managed mutual funds with annual investment fees in the neighborhood of 1%, the brokerage window could allow you to access ETFs charging as little as 0.1%. That means you could end up paying something like 0.15% instead of 1%.
If your plan has low-cost broad market index funds, however, a brokerage window offers less value. Say you want to add more more specialized investment options, such as a REIT or emerging market fund. Even if you have $200,000 in your 401(k), you’ll probably only invest a small amount in these more exotic investments—perhaps $5,000 or $10,000. So a $100 brokerage fee would increase your overall costs on that slice of your portfolio to 1% to 2%. Plus, you’ll pay brokerage commissions and fund investment fees. In that case, better to leave the escape hatch shut.
With the fastest-growing segment of the global population aged 60 and over, biotech, medical devices, drugs and health care services all make for a durable investing strategy.
For health care, gray is the new black.
The fastest-growing segment of the global population is aged 60 and over, according to the United Nations Department of Economic and Social Affairs. That slice of humanity is expected to increase by 45% by 2050.
The surge in the older population has contributed to a wave of new product introductions in biotechnology, medical devices and pharmaceuticals, and expansion of health care services.
In addition, health care is a remarkably durable sector for investors, soldiering on despite periodic market downturns, like the one seen last week when the S&P 500 index had its worst week since 2012.
Overall, there’s a bounty of money being spent on healthcare that’s unlikely to be impacted by other economic trends.
One of the best ways to own the biggest players in the health care industry is through the Vanguard Health Care ETF, which holds global giants like Johnson & Johnson JOHNSON & JOHNSON JNJ -2.1484% , Pfizer PFIZER INC. PFE -1.4204% , and Merck MERCK & CO. INC. MRK -0.9615% .
Charging 0.14% in annual management expenses, the Vanguard fund, which is almost entirely invested in U.S.-based stocks, gained 20% for the 12 months through Aug. 1, compared with 15% for the S&P 500 Total Return Index. Long-term, the Vanguard fund has been a solid performer, averaging 10.5% annually for the decade through Aug. 1. That compares with an average 7% return for the MSCI World NR stock index.
For more non-U.S. exposure, consider the iShares Global Healthcare ETF, which charges 0.48% for annual expenses.
The iShares fund has about 60% of its portfolio in North American stocks, with the remainder in European and Asian-based companies such as Novartis, Roche Holding, and GlaxoSmithKline GLAXOSMITHKLINE PLC GSK -0.1523% . The fund gained 19% over the 12 months through Aug. 1.
For a more focused play on leading-edge biotech and genomic companies, the First Trust NYSE Arca Biotech Index ETF samples some of the hottest companies in that sub-sector. Holdings include industry leaders Gilead Sciences GILEAD SCIENCES INC. GILD -0.8079% , Biogen Idec BIOGEN IDEC INC. BIIB -2.2097% , and InterMune .
The First Trust fund was up nearly 25% for the 12 months through Aug. 1; it charges 0.60% in annual expenses.
Good Valuations Available
Since most institutional portfolio managers have seen the merits of health care stocks for years, there are probably few bargains available, although some sectors are pricier than others. Biotech stocks, in particular, are in high demand, although they experienced a sell-off earlier this year.
“On the other hand,” Fidelity Investments analyst Eddie Yoon said in a recent report, “some large-cap, stable growth companies across the [health care] sector continue to appear attractive, based on their stable underlying business fundamentals.”
Unlike other sectors such as consumer discretionary that are directly tied to overall economic conditions, health care is often insulated from broader economic trends. When the S&P 500 index dropped 37% in 2008, the Vanguard fund only lost 23%; the First Trust fund was off 18%. While biotech stocks tend to be volatile, the mainstream health care companies are seen as defensive holdings and more immune to broader market pressures and poised for bankable growth.
Long term, the more volatile biotech stocks of today may be tomorrow’s winners. The growing science of genomics will allow biotech companies to customize drugs to a patient’s genetic make-up. Just three years ago it cost $95 million to sequence a human genetic code. Now it costs about $4,000, with the price dropping every year. That will translate into more precise treatments with fewer side effects.
There are several concurrent waves of innovation in health information technology, diagnostics and delivery of services. More patients can be monitored and treated at home with the improvement in information technology. Diseases are being discovered and treated earlier, which means fewer hospitalizations.
In the United States alone, health care spending is buoyed by the $3 trillion spent annually on Medicare patients. While policymakers say this number is unsustainable and must be reined in, that does not change a key fact: Some 10,000 Baby Boomers are turning 65 every day. They will continue to demand the best drugs and treatments.
A new ETF seeks to mimic the best ideas of billionaires like Warren Buffett and Carl Icahn based on their public holdings. Trouble is, the fund can't copy them in real time.
Mom-and-pop investors hoping to emulate the investment savvy of Wall Street’s wealthiest like Warren Buffett and Carl Icahn will have a new option on Friday when the latest low-cost exchange-traded fund tracking the stock picks of big-name investors begins trading.
The Direxion iBillionaire ETF, set to trade under the ticker “IBLN,” is the latest in a handful of similar ETFs that have come to market in recent years, all packaging the holdings disclosed quarterly by top investment managers into instruments that are more accessible to Main Street investors.
“It democratizes a lot of the information that very wealthy institutional investors have had for a long time,” said Brian Jacobs, president of Direxion Investments, the ETF provider that has partnered with index creator iBillionaire.
At $65 for every $10,000 invested, fees for the new iBillionaire ETF are far lower than the $200 that would be charged by the typical billionaire-run hedge fund, which would also tack on performance fees.
To be sure, the iBillionaire ETF, like the similar Global X Guru ETF launched in 2012, focuses only on the long portion of these billionaire portfolios and does not include day-to-day active management or any shorting of stocks. Furthermore, the practicalities of pulling investment ideas from the quarterly reports filed by these large investors means that the investment ideas often lag by at least 45 days.
The new ETF is based on an index created in November by startup firm iBillionaire. The fund and its underlying index include the 30 top U.S. companies in which a pool of selected billionaire investors have invested the most assets, based on the so-called 13F disclosures the investors must file quarterly with the U.S. Securities and Exchange commission. Top holdings in the index right now include Apple, Micron Technology and Priceline, with about a third of its portfolio in technology stocks.
“Billionaires are more bullish on technology” right now, said Raul Moreno, chief executive officer and co-founder of iBillionaire. “You can see that by their allocation and their strategies.”
The ETF is similar to the GURU ETF and AlphaClone Alternative Alpha ETF, which both launched in 2012. While they had both beat the benchmark S&P 500 index with stellar performances in 2013, they have been more lackluster this year, with GURU up 0.6 percent and ALFA up 0.3%, compared to the S&P 500, up 4.5% through Thursday’s close.
So far, these funds have a niche following – The GURU ETF has amassed about $499 million in assets, while the ALFA ETF has amassed $79 million in assets. So the billionaires being copied need not worry about losing clients to them, said Ben Johnson, an analyst with research firm Morningstar.
For a related story, see:
Sometimes it pays to follow the crowd. At other times, you'll get burned.
All too often, I see investors heading in the wrong direction en masse. They buy stocks at the top of the market or bonds when interest rates are heading up.
Occasionally, though, active investors may be heading in the right direction. A case in point has been the flow of money into certain exchange-traded funds in the first half of this year.
Reflecting most hot money trends, billions of dollars moved because of headlines. The Energy Select SPDR ENERGY SELECT SECTOR SPDR ETF XLE -2.0415% exchange-traded fund, which I discussed three weeks ago, gathered more than $3 billion in assets in the first half, when crude oil prices climbed and demand for hydrocarbons remained high.
The Energy SPDR, which charges 0.16% for annual management expenses and holds Exxon Mobil EXXONMOBIL CORP. XOM -1.2653% , Chevron CHEVRON CORP. CVX -1.3996% , and Schlumberger SCHLUMBERGER LTD. SLB -2.7928% , has climbed 22% in the past 12 months, with nearly one-third of that gain coming in the three months through July 18. Long-term, this may be a solid holding as developing countries such as China and India demand more oil.
“We think the Energy Select SPDR is a play of oil prices remaining high and supporting growth for integrated oil & gas and exploration and production companies,” analysts from S&P Capital IQ said in a recent MarketScope Advisor newsletter.
Headlines also favored European stocks as represented by the Vanguard FTSE Developed Markets ETF VANGUARD TAX MANAG FTSE DEVELOPED MKTS ETF VEA -1.2327% , which holds leading eurozone stocks such as Nestle, Novartis NOVARTIS AG NVS -0.9667% , and Roche. The fund has been the top asset gatherer thus far this year, with $4 billion in new money, according to S&P Capital IQ.
As Europe continues to recover over the next few years and the European Central Bank keeps rates low, global investors will continue to benefit from this growing optimism.
The Vanguard fund has gained nearly 16% for the 12 months through July 18. It charges 0.09% in annual expenses and is a solid holding if you have little or no European exposure in your stock portfolio.
Not all hot money trends make sense, however. As the economy accelerates and interest-rate hikes look increasingly likely, investors are still piling money into bond funds, which lose money under those circumstances.
The iShares 7-10 Year Treasury Bond ETF ISHARES TRUST 7-10 YEAR TREASURY BD ETF IEF 0.8401% , which holds middle-maturity U.S. Treasury bonds, continued to rank in the top 10 funds in terms of new money in the first half. The fund, which holds nearly $5 billion, is up nearly 4% for the 12 months through July 18, compared with 4.2% for the Barclays U.S. Aggregate Total return index, a benchmark for U.S. Treasuries. The fund charges 0.15% in annual expenses.
While investors were able to squeeze a bit more out of bond returns in the first half of this year, they may be living on borrowed time.
The U.S. Federal Reserve confirmed recently that it would be ending purchases of U.S. Treasury bonds and mortgage-backed securities in October. This stimulus program, known as “QE2,” has kept interest rates artificially low as the economy has had a chance to recover.
The phasing out of QE2 could be bearish for bond funds.
Will interest rates climb to reflect growing demand for credit and possibly higher inflation down the road? How will the ending of the Fed’s cheap money program affect U.S. and emerging markets shares?
Many pundits believe public corporations may pull back from their enthusiastic stock buybacks and trigger a correction. Yet low inflation and modest employment gains may mute bond market fears.
“The Fed is on track to complete tapering in the fourth quarter, and we think there is essentially no chance that it will move the fed funds rate higher this year,” Bob Doll, chief equity strategist with Nuveen Investments in Chicago, said in a recent newsletter.
“With the 10-year Treasury ending the quarter at 2.5%, the yield portion of this forecast is more uncertain,” Doll added, “although we expect yields will end the year higher than where they began.”
While there could be any number of wild cards spoiling the party for stocks, it is wise to ignore short-term trends and prepare for the eventual climb in interest rates.
That means staying away from bond funds with long average maturities along with vehicles like preferred stocks and high-yield bonds that are highly sensitive to interest rates.
Longer-term, shares of companies in consumer discretionary, materials and information technology businesses likely to benefit from a global economic resurgence will probably be a good bet.
Just keep in mind that the hot money can be wrong, so build a long-haul diversified portfolio that protects against the downside of a torrid trend going from hot to cold.
Two new products let you invest in companies led by female executives. Whether this is a good idea depends on what you hope to achieve.
On Thursday, Barclays is launching a new index and exchange-traded note (WIL) that lets retail investors buy shares — at $50 a pop — of a basket of large U.S. companies led by women, including PepsiCoPEPSICO INC. PEP -0.4727% , IBMINTERNATIONAL BUSINESS MACHINES CORP. IBM -1.4013% , and XeroxXEROX CORP. XRX -1.1338% . This should be exciting news for anyone disappointed by the lack of women in top corporate roles.
The new ETN is not the only tool of its kind: This past June, former Bank of America executive Sallie Krawcheck opened an index fund tracking global companies with female leadership — and online brokerage Motif Investing currently offers a custom portfolio of shares in women-led companies.
The big question is whether this type of socially-conscious investing is valuable — either to investors or to the goal of increasing female corporate leadership. Is it wise to let your conscience dictate how you manage your savings? And assuming you care about gender representation in the corporate world, is there any evidence that these investments will actually lead to more diversity?
Here’s what experts and research suggest:
Getting better-than-average returns shouldn’t be your motivation. Beyond the promise of effecting social change, the Barclays and Pax indexes are marketed with the suggestion that woman-led companies tend to do better than peers. It’s true that some evidence shows businesses can benefit from female leadership, with correlations between more women in top positions and higher returns on equity, lower volatility, and market-beating returns.
But correlation isn’t causation, and other research suggests that when businesses appoint female leadership, it may be a sign that crisis is brewing — the so-called “glass cliff.” Yet another study finds that limiting your investments to socially-responsible companies comes with costs.
Taken together, the pros and cons of conscience-based investing seem generally to cancel each other out. “Our research shows socially responsible investments do no better or worse than the broader stock market,” says Morningstar fund analyst Robert Goldsborough. “Over time the ups and downs tend to even out.”
As always, fees should be a consideration. Even if the underlying companies in a fund are good investments, high fees can eat away at your returns. Krawcheck’s Pax Ellevate Global Women’s fund charges 0.99% — far more than the 0.30% fee for the Vanguard Total World Stock Index (VTWSX). Investing only in U.S. companies, the new Barclays ETN is cheaper, with 0.45% in expenses, though the comparable Vanguard S&P 500 ETF (VOO) charges only 0.05% — a difference that can add up over time:
If supporting women is very important to you, you might consider investing in a broad, cheap index and using the money you saved on fees to invest directly in the best female-led companies — or you could simply donate to a non-profit supporting women’s causes.
If you still love this idea, that’s okay — just limit your exposure. There is an argument that supporting female leadership through investments could be more powerful than making a donation to a non-profit. The hope is that if enough investor cash flows to businesses led by women, “companies will take notice” and make more efforts to advance women in top positions, says Sue Meirs, Barclays COO for Equity and Funds Structured Markets Sales in the Americas. If investing in one of these indexes feels like the best way to support top-down gender diversity — and worth the cost — you could do worse than these industry-diversified offerings. “Investing as a social statement can be a fine thing,” says financial planner Sheryl Garrett, “though you don’t want to put all of your money toward a token investment.” Garrett suggests limiting your exposure to 10% of your overall portfolio.
With marijuana legalization riding high, investors are looking for ways to play the trend. So far, though, even the biggest companies in this green rush have yet to turn a profit.
Earlier today, pot went on sale legally in Washington state for the first time ever, following in the footsteps of Colorado. A day earlier, New York became the 23rd state to permit the use of medical marijuana.
Throughout the country, marijuana legalization is going ganja-buster — leading many to wonder how they can profit from this trend.
Several private equity funds recently launched to invest in marijuana-related companies and startups, including one led by none other than the bobo bible, High Times magazine.
But what about retail investors? You’d think that the mutual fund and exchange-traded fund industries would have jumped on this green rush already. After all, there are specialty ETFs that let investors bet on such niche trends as fertilizer, fishing, and even water. But so far such an investment vehicle remains a pipe dream.
In the absence of a simple, off-the-shelf fund, investors can turn to individual equities. But be careful: Many stocks that are trying to ride the Pineapple Express are tiny micro-cap companies or penny stocks that are quite volatile and risky. Moreover, regulators have begun warning investors to watch out for pot-related “pump-and-dump” schemes, in which speculators talk up a stock and then sell before their inflated projections lose air.
In the Ganja universe, here are some of the biggest companies, based on market value, with their strategies and risks highlighted. Keep in mind that all of these “big” marijuana stocks are actually shares of tiny, still-profit-less companies.
GW Pharmaceuticals (Ticker: GWPH; share price: $92.60; market value: $1.4 billion)
Strategy: Cannabis-based pharmaceuticals. The company’s Sativex is already being used in several countries to treat spasticity related to multiple sclerosis. GW is also working on a treatment for severe childhood epilepsy based on cannabis extract.
YTD Performance: +132.3%
2013 Performance: N/A
2012 Performance: N/A
Valuation: Price/sales ratio: 29.0 (S&P 500’s P/S ratio: 1.8)
Medbox (MDBX; $17.75; $537 million)
Strategy: Dispensary services. The company manufacturers self-service kiosks that dispense
medicines including marijuana.
YTD Performance: —0.3%
2013 Performance: —70.1%
2012 Performance: +4,819.4%
Valuation: Price/sales ratio: 77.5
Cannavest (CANV; $11.37 $381 million)
Strategy: Makes and markets cannabis related products, including hemp oil.
YTD Performance: —60.0%
2013 Performance: +470.0%
2012 Performance: +150.0%
Valuation: Price/sales ratio: 44.8
Advanced Cannabis Solutions (CANN; $7.50; $101 million)
Strategy: Leases growing space and related facilities to licensed marijuana business operators.
YTD Performance: +138.5%
2013 Performance: +221.8%
2012 Performance: —99.0%
Valuation: Price/sales ratio: N/A
Medical Marijuana (MJNA; $0.20; $105 million)
Strategy: A holding company with diversified businesses ranging from consumer products to services, including security and surveillance for cannabis-related businesses.
YTD Performance: +27.1%
2013 Performance: +53.5%
2012 Performance: +512.1%
Valuation: Price/sales ratio: N/A
GrowLife (PHOT; $0.10; $81 million)
Strategy: A marijuana equipment maker that sells hydroponic gardening gear.
YTD Performance: —27.8%
2013 Performance: +308.1%
2012 Performance: —75.3%
Valuation: Price/sales ratio: 11.4
Cannabis Sativa (CBDS; $6.40; $75 million)
Strategy: The former sun-tanning company is pushing into the marijuana industry, producing cannabis-based oils and edibles. Its new CEO is Gary Johnson, the former Libertarian Party presidential candidate and a two-term governor of New Mexico.
YTD Performance: +990.0%
2013 Performance: —11.0%
2012 Performance: +12.4%
Valuation: Price/sales ratio: 1000.0
Q: Does investing in a “total stock market index fund” give you diversified exposure to large-, medium-, and small-sized companies? Or do I need to invest in separate mutual funds for my large- and small-company stocks? — Toby, Davis Junction, IL
A: No, you don’t need separate funds. The Vanguard Total Stock Market ETF VANGUARD INDEX FDS TOTAL STOCK MARKET ETF VTI -1.3137% is designed to give you exposure to a broad cross-section of different types of domestic equities in a single exchange-traded fund.
Its portfolio breaks down like this: around 72% is invested in large companies, a little less than 20% is in medium-sized businesses, about 6% is in small-company shares, and 3% is in so-called micro-cap stocks.
Now, you can achieve similar diversification by allocating your dollars into a collection of more narrowly constructed funds that focus on industry-leading large companies or quick-growing but volatile small companies.
For instance, you could pick up Money 50 funds Schwab S&P 500 Index SCHWAB CAPITAL TST S&P 500IDX SEL SWPPX -1.3128% , with iShares Core S&P Mid-Cap ISHARES TRUST REG. SHS S&P MIDCAP 400 IDX ON IJH -1.3456% and iShares Core S&P Small Cap ISHARES TRUST CORE S&P SMALL-CAP ETF IJR -1.3519% . (Although, if you’re not careful, you might end up with more exposure to smaller companies than you want. About 30% of IJR’s portfolio is in micro-cap stocks.)
All things being equal, says BKD Wealth Advisors’ portfolio manager Nick Withrow, you’re better off going with the one fund than three or four.
For one thing, each fund comes with its own expenses. If VTI dovetails with your risk tolerance, then you’ve taken care of your domestic stock portfolio at a measly cost of 0.05% of assets annually. That’s marginally cheaper, by about 0.06 percentage points, than buying a host of exchange-traded funds that collectively approximate VTI’s portfolio, says Withrow.
But there’s another reason — you.
Basically, you don’t want to get into the business of buying and selling ETFs to try and time the market. And you’re much less likely to get into that expensive habit if you buy-and-hold one fund, rather than picking three or four.
“The more choices an investor has, the more apt he or she is to feel that they have to do something,” says Withrow. “The idea of simplicity, especially with a buy-and-hold attitude, goes a long way.”
Of course, one total market exchange-traded fund doesn’t mean your portfolio is complete. Don’t forget about foreign equities or, you know, bonds. But when it comes to U.S. stocks, one cheap total market ETF (like VTI) is particularly useful.
Even with $1 trillion in exchange-traded fund assets, BlackRock is being forced to slash costs on ETFs to compete with low-cost leader Vanguard.
Even as BlackRock is set to amass $1 trillion in exchange-traded fund assets in its iShares business, U.S. retail investors increasingly prefer to send their money to low-cost leader Vanguard.
With $998 billion in ETF money, BlackRock has more than the next contenders, Vanguard and State Street, combined.
But the company has struggled to compete with Vanguard, known for its investor-friendly low-cost investing, for mom and pop’s nest eggs. Retail investors now account for more than half of the $1.8 trillion in ETF assets under management in the U.S, according to consulting firm PwC.
So far this year, Vanguard has pulled in about $30.3 billion in net new ETF money in the U.S., or about 43% of the market, while iShares is second with $24.7 billion, or about 35%.
That reflects a trend that’s been going on for years: At the end of 2009, BlackRock had 47.7% of total U.S. ETF assets under management, compared with 11.7% for Vanguard. By the end of May, BlackRock’s market share was down to 38.9%, compared with 20.6% for Vanguard, according to Lipper.
“Our aspiration is to be number one in flows, and we can’t get there without being higher in the retail market place,” said Mark Wiedman, the BlackRock executive who heads the iShares business globally, speaking at the company’s annual meeting in New York in June. “We are starting to change our voice for that audience and I would say historically we frankly haven’t done that good a job.”
The market share loss comes in spite of BlackRock’s two-year effort to win retail investors.
BlackRock introduced a line of low-cost “buy and hold” investor-aimed ETFs in 2012, and since then has been cutting the fees on its ETFs, revamping its sales team, and pushing a new branding campaign. The firm has cut expenses on 12 funds since 2012, ranging from its S&P Total U.S. Stock Market ETF then to its high-dividend ETF in June 2014.
BlackRock says its flows have improved since it started its new retail effort.
One of the most significant price reductions was in its iShares High Dividend ETF. The cost to investors for that fund dropped to 0.12% of assets a year from 0.40%, a move that would cost BlackRock $11.2 million annually, based on the $4 billion in the fund. Last quarter, iShares ETFs generated some $765 million in base fees revenue.
“Every basis point that you cut a fee impacts revenues, but we don’t really look at that — we look at the profitability of our ETF business over the long term,” BlackRock executive Frank Porcelli, head of U.S. Wealth Advisory Business, said at Reuters’ Global Wealth Management Summit in June.
Asked about how fee cuts would affect BlackRock’s profits, he said it was “not relevant.”
With $4.4 trillion in total assets among its various product lines, BlackRock remains the world’s largest asset manager and is unlikely to be eclipsed by Vanguard anytime soon.
BlackRock has nearly tripled the size of the iShares business since it bought it from Barclays five years ago, largely by selling to big institutions, such as the Arizona State Retirement System, which plunked down $300 million to seed three iShares funds last year. It has also won institutional and retail investors abroad; BlackRock has a strong presence in Europe, Asia, Canada and Latin America. Total BlackRock ETF assets outside of the U.S. are about $280.5 billion, about 36 percent of the $700 billion total market.
Analysts say that iShares’ size and scale makes the effect of fee cuts in the near-term fairly minimal on the overall business, but that a prolonged price war could hurt the firm.
“It’s a tough spot to be in,” said Edward Jones analyst Jim Shanahan. “There is some growth potential there, but it is slow to materialize and it has to be powerful enough to offset the addition of a lot of these products with fees less than the current weighted average fee rate.”
Vanguard, which unlike BlackRock isn’t publicly traded, offers significantly cheaper funds. The average expense ratio of a Vanguard ETF is 0.14%, or $14 for every $10,000 invested, compared with the industry average of 0.58%. BlackRock’s average expense ratio is 0.32%.
“When talking about large, commoditized ETFs, low cost makes a big difference, and Vanguard is a little bit more competitive,” said Gabelli & Co analyst Macrae Sykes.
“Investors recognize Vanguard as the low-cost leader — whether for index funds, for active funds, for bond funds, for money market funds, or for ETFs,” said Vanguard spokesman David Hoffman. “We like to say that we’ve been lowering the cost and complexity of investing for 38 years. We are also increasingly being recognized for our commitment to providing high-quality products that can play an enduring role in a portfolio.”