Building an ETF Portfolio

My spouse and I decided to convert one of our IRAs to a portfolio of index-based exchange traded funds (ETFs). We looked primarily at Vanguard and iShares index-based ETFs. We put together a list of candidate ETFs by asset class.

Both family of funds have relatively low expense ratios, with Vanguard being the lowest. Except for two micro cap ETFs, we eliminated any ETFs that had an expense ratio higher than 50 basis points (0.50%). We also built a worksheet to help allocate funds among the various asset classes. You can see the results of this research and the ETF worksheet in a Google spreadsheet or the original Excel spreadsheet.

Parking Your Safe Money

This is a response to a question by one of my young adult children. She was looking for a place to put some safe money (i.e., funds that she might need in the next 1-3 years) and wanted to obtain a better rate of interest than that offered by her bank.

Vanguard money market funds are a good place to park money that you may need in the next 1-3 years. At your tax bracket, I would not worry about finding a tax-free fund. Tax free money market funds don’t become advantageous until you reach the 28% tax bracket or higher. You can ask Vanguard for a check book for your money market account and redeem shares by check. However, the check has to be $250 or more.

Here are three suggestions. The fund are listed with the safest funds first. The spread between the Treasury-based fund and the prime rate fund is very small. It comes out to about a $25 per year difference on $10,000. So you might want to stay with safety (either Treasury or Federal). That way if the world goes nuts, your funds will be secure. (more…)

First Quarter 2007

For the quarter ending March 30, the Moose Pond portfolio increased in value by 2.9%.  In comparison, the S&P 500 increased 0.18% for the same period.  See the portfolio performance report for the quarter.

The top five advancers for the quarter were SYK (+20.8%), IFIN (+16.9%), GYI (+13.6%).,CAH (+13.4%), and JKHY (+12.7%).  The laggards were AMGN (-18.2%), JNJ (-8.4%), INTC (-5.0%), CBH (-5.0), and BRO (-3.9).

Other than normal dividend reinvestment activity, we bought WAG and added to our position in JNJ.  We bought more Vanguard total stock market index (an exchange traded fund) as a holding place for funds available to invest.  We sold UTSI and IFIN.  (IFIN was acquired by another company.)

An ETF Portfolio

Here is a portfolio made up of exchange traded funds.  This portfolio has no bond or fixed income component.  It provides both relatively high return and moderate volatility making it appropriate for the long term.

The portfolio currently has an asset allocation of:  45% domestic stocks, 35% international stocks, and 20% REITs.  The portfolio was rebalanced earlier this year to include greater international exposure. 

This portfolio includes 13 ETFs and one index fund.  The ETFs and one index fund are based on broad market indices.  Vanguard ETFs predominate because they offer the lowest expense ratios and they closely track the market indices they track.

An ETF-based portfolio does not have include this many different subclasses of assets. A total of three three to five ETFs is all that is needed to get the benefit of diversification across different asset classes. Here are two examples:

• A 3-ETF Portfolio – 50% Vanguard Total Stock Market ETF (VTI) ; 35% iShares MSCI EAFE Index Fund (EFA); and 15% Vanguard REIT ETF (VNQ)
• A 5-ETF Portfolio – 30% Vanguard 500 Index (VFINX ) or Vanguard Large-Cap ETF (VV) ; 20%Vanguard Small Cap Value (VBR); 20% iShares MSCI EAFE Index Fund (EFA); 15% Vanguard Emerging Markets ETF (VWO); and 15% Vanguard REIT ETF (VNQ)

Note:  VFINX is an index mutual fund.  However, it can be purchased through an on-line broker.

Not all ETFs are the same

In a recent letter to the editor of the Wall Street Journal, John Bogle cautions that of the 690 exchange traded funds (ETFs) in existence today, only 12 represent broad market segments, such as the S&P 500, the Dow Jones Wilshire Total (U.S.) Stock Market Index, and the Morgan Stanley EAFE (Europe, Australia and Far East) Index of non-U.S. stocks.

However, he goes on to comment: ETFs, simply put, are index funds that can be traded in the financial markets. In fairness, if they are not traded, they can often be the equal of the classic index funds.

ETFs that represent broad market indices offer several advantages to the small investor. First, they can be traded like stocks, there is no minimum purchase. When the corresponding index fund is purchased outside of an IRA, there is usually a minimum ($3,000 for many of the Vanguard funds).  Second, the ETFs typically have a slightly lower expense ratio. For example, the Vanguard Total Stock Market Index Fund Investor Shares (VTSMX) is a mutual fund with an expense ratio of 0.19%. The Vanguard Total Stock Market ETF (VTI) is the corresponding exchange traded fund and has an expense ratio of 0.07%. For a $10,000 investment, the 0.12% difference in expenses would result in $12 in buying the ETF.  This enough to offset the commission, assuming it is purchased through a discount broker.

Learn more about index fund investing at the Bogle Financial Markets Research Center and The Bogle eBlog.

ETF and Index Investing

While selecting stocks and building a solid portfolio can be rewarding, not everyone has the time or interest to do so. Also, core portfolio assets (e.g., the money you need to retire) deserve special protection. Index funds and exchange traded funds (ETFs) make it possible to build a diversified, tax efficient portfolio that requires little maintenance beyond periodic (quarterly or annual) rebalancing. Using ETFs or index funds to diversify among several asset classes increases the long term rate of return and reduces portfolio risk.

An index fund is a mutual fund consisting of stocks that correspond with a market index. An ETF is a stock certificate reflecting underlying assets that correspond with a market index. Index funds are bought and sold like mutual funds, i.e., at the end of each trading day. ETFs trade continuously traded throughout the business day on the major exchanges like other stocks.

Index funds can be purchased through some of the large family of funds. Vanguard and Fidelity offer a wide range of low cost index funds. You also can purchase index funds through a broker, but this usually results in a brokerage fee. Since ETFs are traded as stocks, they can be purchased through any broker. While there is a brokerage fee for purchasing ETFs, there is no minimum dollar amount or number of shares. Since they are mutual funds, index funds require some minimum purchase. For smaller portfolios, it may be easier to diversify using ETFs. (more…)