It’s not often I get to be the little guy…
You don’t have to read very far around here before realizing I am a huge proponent of investing with Vanguard. They are the only investment firm I recommend and, other than our bank account for paying routine bills, all of our investments are with them.
You also don’t have to read very far to know I suggest that all any of us really need are two of Vanguard’s funds: VTSAX for our stocks and VBTLX for our bonds. This is, after all, The Simple Path to Wealth.
While many financial writers agree with the former, to my knowledge I am the only one to have the temerity to suggest the latter.
Recently a friend, having read my book, decided to move her assets to Vanguard. Since she had enough to qualify for a free consultation with an advisor there, she decided to listen to what he had to say and the investments he suggested.
Disappointingly, he wasn’t forthcoming in explaining his thinking behind the recommendations. She was curious as to my thoughts and any insights I might care to offer. Perhaps you might be too.
Here’s the recommended portfolio, along with the expense ratio (ER) for each fund and the percentage allocation:
15% — VBTLX — Bonds — .06% ER — Total (US) Bond Market Index Fund
15% — VTSAX — Stocks — .05% ER — Total (US) Stock Market Index Fund
20% — VFIAX — Stocks — .05% ER — (US) 500 Index Fund
05% — VEXAX — Stocks — .09% ER — Total Extended Market Index Fund US Mid-Small Cap Stocks
30% — VTIAX — International Stocks — .12% ER — Total International Stock Market Index Fund
15% — VTABX — International Bonds — .14% ER — Total International Bond Market Index Fund
The first two are our old friends and in my view are all anyone really needs. My recommendation to her (and you) is to buy these two funds and adjust the allocation between them to suit her (your) personal risk profile and needs, as described here; keeping in mind that if you plan to use the 4% rule to guide your withdrawals, you’ll want to hold at least 50% stocks.
But while I suggest only these two make up 100% of her portfolio, they are only 30% of the Vanguard recommendation. What’s with the disconnect and, more importantly, who’s off track here?
Let’s take a closer look and see what we can tease out.
Stock to bond allocation
Looking at the Vanguard portfolio, we see four of the six suggested funds are stock funds, the other two are bond funds and, looking at the percentage allocations, we also see that the overall recommendation is for 70% Stocks and 30% bonds. So far so good. 70/30 (VTSAX/VBTLX) is just about what I would recommend to this particular friend given what I know of her circumstances.
Point: Draw
Costs
My two funds have ERs (expense ratios) of .05% and .06%, but these two make up only 30% of the Vanguard recommended portfolio. The other four funds — 70% of the total — have ERs ranging from .05% to .14% and while I’ll let one of my astute readers do the precise math, at a glance we can see this more than doubles the portfolio’s costs.
Point: jlcollinsnh (although even the Vanguard portfolio has admirably low costs compared to most alternatives)
International funds
The bulk of this extra cost goes to providing exposure to international stocks and bonds. Indeed fully 45% of this portfolio is international.
45% is breathtakingly high for a US-based investor. Most recommendations for international exposure I’ve seen range from 10-25%. So what are they thinking?
My best guess is that this advisor is looking at the world markets and the fact that the US accounts for about 55% of the total. If you believe as a US-based investor in adding international, this makes sense. It is likely what I’d do. If I felt the need for international exposure. But I don’t.
I’m on record as suggesting you don’t need international at all for these reasons.
Let me be the first to tell you, this position makes me a major outlier. The vast majority of investment writers pound the table for international. But I’ve yet to see a persuasive case. You are welcome to read my post in the link above and the writings of others and decide for yourself.
Meanwhile, out here in the wilderness I’ll console myself with the company I keep:
Bogle and Buffett
Where I simply don’t see the need for international, Jack Bogle holds the view that not only is it unnecessary, it is an unacceptable risk:
Jack Bogle wouldn’t risk investing outside the US
Warren Buffett’s suggestion for his widow when the time comes is this:
“My advice to the trustee couldn’t be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions or individuals — who employ high-fee managers.”
Point: Depends. Jack, Warren and I say jlcollinsnh. But in that so many out there feel this need for international, I’m willing to call it a Draw.
But what’s up with those wacky US stock fund suggestions?
So far the Vanguard rep and I agree on the basic stock/bond allocation but disagree on the need for international. Although I will say, if you are going to add international, his are the same choices I would suggest.
But what really baffles me are the three US stock funds he suggested. I mean, WTF?
VTSAX, the fund I recommend, holds virtually every publicly traded company in the US — 3,635 as of this writing.
Because each holding is “cap weighted” (meaning the larger the company the greater percentage of the index it accounts for) the top ten companies account for ~15.6% of the total index. By extension the top 500 companies make up ~80% of the index. The other ~20% is made up of mid and small cap stocks.
It is because I like the idea of holding some small and mid-cap stocks that I prefer VTSAX to Vanguard’s S&P 500 fund VFIAX. With VTSAX we get those 500 big guys plus the remaining 3,135 smaller companies we hope might grow into tomorrow’s big guys.
But while the Vanguard rep does indeed recommend VTSAX, he then goes on to add VFIAX – the 500 Index Fund to it.
Now this might make sense if the rep believed that a 20% small and mid-cap allocation was too high and he wanted to over-weight large cap stocks. Except…
…he then goes on to add MORE small and mid cap exposure with Vanguard’s VEXAX Total Extended Market Index Fund US Mid-Small Cap Stocks.
This makes absolutely no sense.
Let’s look at the math.
The V-rep is recommending 40% of the portfolio be in US-based stocks spread across three funds.
15% in VTSAX. Since VTSAX is ~80% in the S&P 500, that’s 12% of the total. The other 3% is in the small and mid-cap stocks.
20% in VFIAX. Add this to the 12% from VTSAX, we have 32% of the 40% total in the S&P 500.
5% in VEXAX. Add this to the 3% from VTSAX, we have the remaining 8% in small and mid-cap stocks.
So, our 40% US stock allocation is made up of 32% large cap and 8% small/mid-cap. And, since 32 is 80% of 40 and 8 is 20% of 40, we have a US stock allocation that is 80% large cap and 20% small/mid cap.
Now, let’s see…
…what was that VTSAX allocation split again? Oh, yeah…
80%/20%
Our Vanguard rep managed to duplicate VTSAX by adding the complexity and expense of two additional funds. Yikes.
Point: jlcollinsnh. Double points!
Anytime you can accomplish the same goals with one fund instead of three at less cost, it deserves double points. Actually I’m awarding myself triple points on this one. Just because I can.
So, WTF?
Now this leads to the uncomfortable question: Why?
- An unkind man might suggest the rep was simply incompetent
- A suspicious woman might suggest he was trying to drive up fees to benefit Vanguard
My guess is the reps are given instructions to…
- Always include international because, after all, everyone does and we have international funds that need support
- Have at least six funds in your recommendation so this doesn’t look too easy
- VTSAX and VBTLX are already huge funds and we have others that need some love
Jack Bogle left the CEO position in 1996 with health issues. Upon his return as “Senior Chairman” it became no secret that Vanguard had begun to drift from his hard-core simple, broad-based index investing principles.
The new management want to grow and to do so they expanded their fund offerings far beyond what Bogle (and I) thought any rational investor needed. Basically, they gave the dogs the dog food they wanted. In doing so they succeeded spectacularly, becoming the largest investment firm in the world with some 3.6 trillion in assets.
But in doing so they have also become less pure than I, and likely Bogle, might prefer.
Does this mean I’ve lost faith in Vanguard? No, not at all. As I said in the opening, I still hold 100% of our investments there and believe they are lightyears ahead of the competition.
Moreover, the portfolio they proposed is not a bad one. Truth is, over time, it would serve her needs just fine and far better and less expensively than most. It is only in comparison to mine and The Simple Path it looks a bit clunky.
I bet Bogle and Buffett would agree.
Addendum 1
Fervent Finance, in the comments below, offers perhaps the best explanation:
It’s probably a risk mitigation strategy. They just want to cover all their bases, so when down the road if small caps or international way outpace other equity classes they can say “hey look – you have those!”
Addendum 2
From Probley in the comments below:
Personal Capital currently categorized VTSAX as
- 69% large
- 18% mid
- 8% small
- 4% real estate
- 1% international
Looking at the composition of the CRSP U.S. Total Market Index (the current VTSAX benchmark), the top 500 holdings are roughly 83% of the total. So if you consider the top 500 as large cap, there’s your 80%.
