Warren Buffett, probably the best stock investor of the past 50 years, made a big splash recently when he revealed that he has requested that 90% of his wife’s share of his estate upon his death be invested in a low-cost fund that tracks Standard & Poor’s 500-stock index.
Buffett is nobody’s fool. It’s difficult, though hardly impossible—as his own example shows—to beat index funds. With index funds, you’re practically guaranteed to beat roughly two-thirds of actively managed stock funds over the long term. What’s more, picking among stocks or actively managed stock funds takes work and skill. Most people would rather invest in a portfolio of index funds—and get on with their lives—without having to constantly reevaluate their investments.
See Also: Don’t Bet Against Warren Buffett
Where I part with Buffett is on his choice of index funds. The S&P 500 is a fine index, but stocks of large U.S. companies dominate it. Why not put your money in a better, more diversified portfolio? Diversification, after all, is the one free lunch in investing. Owning index funds that invest in small and midsize companies, as well as in foreign stocks, can boost your potential return.
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Below are seven exchange-traded funds you can buy and hold for a lifetime. I’ve made some tweaks from a similar story I wrote a year ago; if you bought based on that piece, the tweaks are optional. All my picks are from Vanguard because its index funds cost little and are reliable—that is, they do an excellent job of tracking their benchmarks. I’ve provided the symbols for the seven exchange-traded funds, but it makes no difference whether you invest in the ETFs or the Vanguard mutual funds’ Admiral shares, which require a $10,000 minimum investment; you’ll pay the same minuscule expenses. If you buy the ETFs or regular funds from a brokerage firm instead of from Vanguard directly, you may also have to pay commissions.
This portfolio is designed for long-term, buy-and-hold investors. It’s not intended to be my best picks for the current market. Indeed, just now I wouldn’t invest much of anything in stocks of companies with small capitalizations; they’re expensive relative to stocks of large companies.
Vanguard Total Stock Market ETF (VTI), 34% of the stock portfolio, tracks the CRSP U.S. Total Stock Market index, which covers the entire U.S. stock market. This fund has 19% of its assets in midsize companies and 9% in small caps. By comparison, the S&P 500 has 12% in mid caps and nothing in small caps. As with all the funds in this article, stocks are weighted by market value (share price times number of shares outstanding). The largest holding is Apple (AAPL), with 2.3% of assets. The average market value of the fund’s holdings is $37 billion. The fund yields 1.9%; expenses are a mere 0.05% annually.
Vanguard Total International Stock Index ETF (VXUS), 22% of the stock portfolio, is the foreign twin of the ETF described above. It reflects the FTSE Global All Cap ex US index. Average market value is $21 billion. Developed markets account for 86% of the fund’s assets, emerging markets the rest. Large companies dominate the fund, but 17% is in mid caps and 3% is in small caps. The ETF yields 2.8% and charges 0.14% annually.
Vanguard Dividend Appreciation Index ETF (VIG), 12% of the stock portfolio, invests only in companies that have hiked dividends in each of the past ten years. It tracks the Nasdaq Dividend Achievers index, which also weeds out companies that fail tests of financial strength—chiefly because they have too much debt. Despite the dividend focus, this fund is not a high yielder; it yields just 2.0%, about the same as the S&P 500. Admittedly, Dividend Appreciation is an unusual index fund, but I’ve included it because of growing academic evidence that high-quality stocks—blue chips with attractive profit margins and dividends—have excelled over the long term. Annual expenses are 0.10%.
Vanguard Extended Market Index ETF (VXF), 12% of the stock portfolio, tracks the S&P Completion index. The fund owns pretty much every tradable U.S. public company, excluding penny stocks and the like, that the S&P 500 doesn’t own. Since 1926, small caps have returned an average of two percentage points per year more than large companies—albeit with greater volatility. All but 6% of this ETF is invested in mid caps and small caps. It charges 0.10% annually.
Vanguard Small Cap Value ETF (VBR), 12% of the stock portfolio, invests in small, undervalued companies by tracking the CRSP US Small Cap Value index. Research shows that small stocks and cheap stocks (those that are inexpensive in relation to earnings and other key measures) have delivered above-average returns over the long term. The average market value of this ETF is $2.7 billion. It charges 0.09% annually.
Vanguard Emerging Markets Stock Index ETF (VWO), 8% of the stock portfolio, tracks the FTSE Emerging Markets index, which includes 850 stocks from 22 developing countries. Emerging markets have trailed U.S. stocks badly since late 2011, but, in my view, that doesn’t mean these fast-growing economies don’t deserve to be among your long-term investments. The fund charges 0.15% annually. What’s in this stock portfolio, and how has it performed? Overall, it has 17% of its assets in small caps and 24% in mid caps. Foreign stocks account for 30% of assets, of which one-third is in emerging markets. Over the past ten years through April 30, the portfolio returned an annualized 9.0%. By contrast, the S&P 500 returned an annualized 7.7% during the same stretch.
The seventh ETF is a bond fund. I’d invest in Vanguard Intermediate-Term Corporate Bond Index ETF (VCIT). This pick is my answer to Vanguard founder Jack Bogle’s complaint that many of Vanguard’s bond index funds contain too many low-yielding Treasuries. The average credit quality of the fund’s holdings is single-A. The fund charges 0.12% annually for expenses and yields 3.1%. As for how the fund would react to rising interest rates—the bête noir of most bond funds—Intermediate-Term Corporate would probably lose about 6.5% of its value if interest rates were to rise by one percentage point.
As far as allocation between stocks and bonds, most investors should probably have 70% to 75% of their portfolio in stock funds. But you’ll want to gradually reduce that as you approach retirement. Even in retirement, though, most people should keep 50% to 60% of their investments in stock funds.
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Value AddedThe Vanguard Group
