After a volatile year of trading I have decided to streamline and simplifying my longer term investing strategy. In a nutshell this means going from holding a bunch of stocks, sector ETFs and mutual funds to just holding three low-cost index funds that provide the diversification and exposure I need. It is also a much more simple and dare I say, prudent way of investing for time constrained, non-professional investors like me.
Experts and research say that 3 core funds should be in this type of passive and diversified portfolio- a US Stock Market Index fund (40%), an International Stock Index (40%), and a Bond Market Index (20%). The weighting across the three fund portfolio should be based on your investment time horizon and risk tolerance. The longer the time horizon the more aggressive you can be, which typically means a higher weighting to stock funds. For a more conservative portfolio the allocation should be geared more towards bond funds.
Maintenance of the 3 fund portfolio is also much easier and should be done on a quarterly basis to ensure the allocation levels are in line with one’s strategy. By contrast if I had to do quarterly maintenance for my current portfolio of stocks, funds and ETFs it would take hours and I still wouldn’t get the diversification I get with the three index portfolio.
Based on the research I did and looking at a variety of fund managers, it really comes to down to Vanguard or Fidelity funds because they provide the lowest cost options for broad based market index funds. The table below provides a comparison of the two large cap US equity fund offerings from each of these two companies. The choice comes down to holding a fund that is mainly focused on the largest domestic companies as measured against the S&P 500, or to get an even broader mix with a total stock market fund that includes S&P 500 stocks plus other small-, mid-, and growth stocks.
From a diversification perspective the total stock market fund is the smarter choice. It contains nearly 3200 shares vs around 500 for the domestic large cap fund. While the expenses are similar, the average returns for the total stock market funds are higher across all time frames. This is likely due to these funds including small and mid cap stocks which tend to provide higher returns over the longer term (albeit for more risk/variability).
So the choice comes down to choosing the Vanguard or Fidelity total stock market fund which both pretty accurately match their benchmark. The Vanguard Total Stock Market Index Fund (VTSAX) is the easy choice here though thanks to its lower expense ratio (0.01% difference to Fidelity which adds up over time) and its marginally higher returns across all time periods.
Also the main reason why I picked index funds over index ETFs was that I want to set up a regular investment plan, so that every month money is taken out of my pay check (before it can be spent on discretionary items) and automatically allocated across these funds in line with my investment strategy. With an ETF, you would have to buy the index ETFs through a brokerage account which is more of a hassle to automate for regular monthly investing.