Greetings fellow Fools.
As an investor I have been managing my own money from the start, with help from Motley Fool, which has taught me a great deal about managing investments.
However, I am also tasked with investing for my daughter and giving advice to other family members, so I generally suggest index ETFs since they are not actively managing their portfolios.
Over the past couple of months I have been reviewing the holdings of multiple index ETFs, and I am concerned that so many of them have basically the same general holdings. For example; most of the S&P 500 index ETFs (VOO, IVV, etc.) and the Nasdaq index ETFs (QQQ), are mostly dominated by the same companies (AAPL, MSFT, META, AMZN, TSLA, NFLX, NVDA, etc.). Even some of the Russell 2000 and 1000 ETFs, like IWO, IWB, VONG, and Morningstar MOAT have more or less the same holdings.
For my daughter, being that she is still in her 20s, I’m trying to keep her portfolio about 50% focused on Nasdaq and S&P 500 ETFs, but to avoid being over concentrated I also want to diversify between ETFs to include small cap, mid cap and international ETFs for a good blend.
Is this a practical approach, and what ETFs should I explore to round out the other half of her portfolio?
Is the allocation for a 401K retirement plan or for a taxable account? If the latter, when will she need the money? If this is a 401K plan, she may not even have specialty ETFs such as midcap ETFs as investment choices.
Why di-worsify in your 20s? In your 20s you should be investing aggressively for growth, and concentration in the highest quality companies helps towards that goal. I would advise to allocate 100% of savings to an index fund in a 401K plan (maxing out the contribution), if this were my daughter. This is assuming she has 3 to 6 months of savings set aside in cash for emergencies.
Her 401K is separate, I advised her to put her 401K into the one an only index MF they have in their plan, which is an SP500 fund.
This is in her private investments, which are divided into traditional and ROTH IRAs, as well as her personal taxable account. I’ve helped her create an emergency fund already, which is invested in high-yeild savings and 3, 6 and 9 month CDs paying over 5%.
I am advising her diversify her investments a little, so I have her putting 50% in Nasdaq and SP500 ETFs, but the largely have the same holdings. What I’m trying to do is diversify the other 50% into small, mid and international stock so it is not all sitting in AAPL, MSFT, AMZN, META, NVDA, TSLA.
BTW - this is why I hate company 401K plans. Most companies don’t bother to think about what funds to offer, they just farm it out to some firm who stacks the plan with their high commission funds. On top of that Fidelity has the nerve to charge an additional 0.05% “administration fee”, besides the MF fees. Sick!
Some ETFs to consider that are not cap-weighted in megacap tech companies.
IWM - iShares Russell 2000 ETF
IJH - iShares S&P Core Midcap ETF
VXUS - Vanguard Total International Stock ETF
For young people, I would advise no more than 30% across all the above categories, and 70% in index funds and QQQ. Take a look at the last 3 bear markets, and you’ll see that diversifying into small caps and midcaps did not help at all.
Here’s a backtest I did at portfoliovisualizer.com that shows that a 70/30 allocation to SPY/QQQ soundly beat a more diversified allocation involving IWM, IJH and VXUS over the past 12 years. Note that the diversification did NOT result in lower drawdowns during bear markets.
The R2000 index (IWM) has lower returns compared to the S&P small-cap index (IJR).
IJR “avoids recent IPOs and considers only profitable stocks for inclusion”
5-year CAGR to 2023
IJR and IWM have similar AUM, around $70B. Why would someone choose IWM?
I replaced IWM with IJR (good suggestion by @laffisloon), and also replaced VXUS with VGTSX (Vanguard Total International Stock Index) which enabled me to extend the backtest to the past 15 years (starting at 2009).
The conclusion is the same. The young investor with a 15-year time horizon in 2009 did far better with a concentrated 70/30 SPY/QQQ portfolio than a di-worsified portfolio that included small caps, international and midcaps in the mix. The annualized return was 16% in the former vs 14% in the latter. You would think that diversifying would have smoothed out the volatility and the drawdowns, but that was NOT the case. The diversified portfolio had the same max drawdowns during bear markets and the same standard deviation as the concentrated portfolio. Facts matter.
@CMFSoloFool @rdutt There has been a lot of writing lately about how much mega-cap tech (the Naz 100/QQQ and S&P) have crushed Value and anything else over the last 10 years. There’s so much institutional money going into all of those SP500 CAP-weighted index funds… it’s almost a perpetual motion machine, but it is also a “crowded trade” - and all equity asset classes have become increasingly correlated to the S&P 500…
I love this chart that Ben Carlson posts annually. Updating My Favorite Performance Chart For 2023 - A Wealth of Common Sense
For diversification away from that hegemony I’d suggest VEU for Foreign Developed, EM for Emerging x-China, DFAS for small caps (with a 20 basis point expense ratio premium, likely worth it), IJT for small cap growth as well; VUG for even “purer” large cap growth/momentum, VNQ or FREL for Real Estate / REITs, and SCZ for Foreign Developed Small Caps.
I still do GTAA and dual momentum at the asset class as a hobby and as Defense against big drawdowns, but I’m ~ your age group. Because Large Caps US has outperformed everything over the last 10 years (as above), I’ve gotten a decent return but “underperformed” the S&P while avoiding the worst of the '22 bear.
There is a tremendous amount of overlap between a number of ETFs. The true SP500 ETFs (SPY, VOO, IVV, etc.) all perform the same, but I guess you can shop for the lowest expense ratio to pick the one you want. I’ve used VOO for my daughter’s portfolio.
Ben Carlson’s chart is a bit confusing, it’s hard to map the categories to the funds. Does SPY map to large caps in his chart? How exactly are the 10 funds that appear to be the source map to the categories in the chart (some may be obvious others not so).
The common wisdom among so-called experts is diversification is supposed to help balance out risk and reward. Some may argue an Index is diversified already (i.e. SPY has 500 stocks, QQQ has 100, R2K has 2000). But from the various points @rdutt made, it appears diversification by market cap doesn’t seem to win out over QQQ. However, drawdowns on QQQ are terrifying, in 2022 the QQQ was down 32.58%, nearly double the 18.17% for SPY, so that may be a motivating factor, especially if you have to withdraw from your accounts during that time. Hence, I have subscribed to the idea of keep two years of income in guaranteed income securities to avoid pulling money out in bear markets. But that is a different topic.
@rdutt - I see the logic in terms of QQQ returns, but I am not conditioned to put everything in one basket. If I was hunting purely for returns, I would put everything in SPXL, which blows QQQ and SPY away, going back even 15 years to the dreaded Great Recession. BTW I have a good chunk of coin in SPXL.
I think the goal is some balance between risk, returns, drawdowns and common sense. But it is hard to argue in such vague terms and with such limited data.
I’m mostly a fire and forget investor, so I don’t pay too much attention sectors or valuations, but I’m also become concerned about how little diversification there actually is these days.
Consider equal weight ETFs like QQQE and RSP. It pretty neatly solves the Big 7 problem and it is nice and simple.
SPXL as a core investment? That’s an interesting, contrarian idea as long as it’s contained with good volatility reducer to balance that off. And hopefully a reasonable trailing stop along with some kind of correction / bear warning signals.
I would not recommend SPXL as a core investment, it has some crazy drawdowns: 56.55% in 2022. But it has trounced QQQ and all index funds: 21.55% annualized over ten-years and 28.60% annualized over 20 years including the 2008 Great Recession. 2023 return was over 69%. Use cautiously, if you can be patient, it rewards handsomely.
@CMFSoloFool I assume your daughter is a GenZ. In what year will she need the money? 20 years from today to pay for her kids’ college expenses? 40 years from today when she needs it for her retirement?
That’s your target investment date. Then pick a target date fund for that year. For example, Fidelity has a target date fund for 2045 - see Vanguard Mutual Fund Profile | Vanguard
The fund will automatically shift to a more conservative allocation (higher percentage in bonds) as the target date nears. It’s simple, boring and effective.
This is what Ramit Sethi, a best selling personal finance author, recommends - 'You want entertainment? Go watch my Netflix show or get a dog': Ramit Sethi says you should invest 'as much money as possible’ into this one specific type of fund — here's why
He teaches other things in his book, too, that is targeted at Gen Z and millenials. Ramit himself is 38 years old and has 85% in stocks, 13% bonds and 2% cash.
NEVER!!! Sacrilige. lol
Seriously, though, most target date funds have very high expense ratios, and their asset allocation models are outdated bunk.
I’ve listened to Ramit’s pod casts, and the interviews he does with couples. Frankly I’m not too surprise he recommends target funds, but I think the context is relevant here… set and forget. IMPO, if you want very simple, hands-off, set an forget, then just go with an S&P500 ETF and be done. Much lower expenses, and it will outperform any target date fund. The trouble is, most 401K investment options are so limited. Few 401Ks offer more than 20 funds, and most of them have insane expenses.