Simple vs. Complex, 2018 Edition (Endowments vs Index Funds)

Simple vs. Complex, 2018 Edition

A few points:

 

So once again the conclusion is keep it simple and go index.

 

Thank you for posting Nodrog.
I think we are all trying to come up with the ultimate portfolio!

 

I think one important point is that complexity generally tends to add to cost. Even with the simple three fund portfolio one (including myself) may at times wonder if it’s worth adding other asset classes such as listed property / infrastructure etc in the hope of benefiting from potential correlation differences and / or increased distribution yield etc.

Firstly these aren’t really separate asset classes but simply Sectors which are already present in the main index. So all one is doing is overweighting these sectors.

Secondly these sectors as part of the main index are managed for a fee of 0.18% as in the case of VGS. But to overweight these Sectors through investing in a dedicated index ETF the fee then is around 0.50%! Once again even with index product that’s a big jump in cost.

Finally the correlation benefit will generally fail when it’s most needed as in a market crash where all correlations on the risk side converge.

The strange thing is Simple is one of the hardest things to do. There is a constant temptation to optimise in thinking that more / complex is better. Knowledge, intelligence, research, dedication, seeking expert opinion and greater complexity etc, all these things that work so well in many professions, generally turn out to be counter-productive when it comes to investing.

 

Another damning report, this time it’s Hedge Funds 2018 report card:

Swedroe: 2018 Report Card For Hedge Funds | ETF.com

 

From the article, the three fund portfolio is US-focused as it uses:

Total U.S. Stock Market Index Fund
Total International Index Fund
Total U.S. Bond Market Index Fund.​

which we can invest in as VTS/VEU(?)/?

For an Aussie investor do you re-state to the Aussie versions of the three funds;
(eg maybe VAS/VGS/VAF)?

 

Yes, excluding bonds, but VTS / VEU are US domiciled.

For locally domiciled ETFs whilst “keeping costs low” that’s about as close as one can get from memory. But unlike the earlier funds mentioned Emerging Markets and Small caps are excluded. EM in particular unfortunately adds to the cost at this time.

I’m no expert on ETFs though as being a retiree I don’t feel the need for EM and small caps. Hence I don’t follow all ETFs available. Accumulators might feel the need for these however.

 

I think I wasn't clear - if I lived in the USA, the three fund portfolio has me include "total US stock market".

So if I live in Australia, do I include "total US stock market" or "Australian stock market"?

Ignore domicile of the funds, it's the underlying investment philosophy I'm trying to understand.

 

Think of it as being local vs International. That is ASX vs the rest which includes the US being part of International equities.

 

Perhaps I’ve confused you earlier with VTS / VEU. Typically a local investor might for example own VAS for local and VTS / VEU or VGS for international. However you may wish to take into account the roughly 2% of ASX included in VEU when allocating to VAS

Put simply:
Local equities
International equities
Local bonds (and international bonds - optional)

 

Local equities: I think most of us get the general ideal of investing locally via VAS or LIC's especially for dividends.

International equities: This is where there is so much choice. Personally I invested heavily via WDIV to seek dividends. It has worked out quite well as I purchased when the Aussie dollar was around parity with the US dollar. I think I now get the advantage of the dividends coming back into Australia at a higher rate due to the Aussie dollar being lower? The only disadvantage is the dividend payments are quite lumpy being I never know what will appear in the bank account.

Bonds/Fixed Interest: They are meant to be defensive assets, I'm struggling as to why it is worth investing in this asset class. Following is an extract from Six Park dated 14 Jul 2017
"we will be reducing the allocations to Australian bonds across most of our portfolios. This change is aimed at reducing the risk posed by potential interest rate rises in the future and is being made under the expert guidance of our Investment Advisory Committee. It aims to ensure our portfolios are in the best possible position to provide optimal investment returns."
Link: Why Six Park is reducing its allocation to Australian bonds | Six Park

 

Thank you - now I understand that it is local/domestic equities!

 

I dream of the Aussie Dollar above parity and US market experiencing a lost decade again.

Bond funds (which is what Six Park invest in) are very different to individual bonds / term deposits. Although some will argue there’s no difference as in this:

Misconceptions About Individual Bonds vs. Bond Funds

However that doesn’t assist my SANF at all. I want to know I’ll get my principal returned in the time frame chosen so Term Deposits suit me better. Bond fund investors will say but what about liquidity for when bond fund zig and equities zag as in correlation. No thanks there’s no guarantee of that happening every time. High interest at call online cash accounts with similar / higher interest return will meet my liquidity needs thank you.

Being at the end of a massive 30 year Bond bull market I think it’s impossible in the foreseeable future for Bond investors to experience the performance and correlation benefits of recent decades. Then again I’m just an ammateur investor but I do need to invest in a manner that provides peace of mind for ME. Hence others will likely disagree with my view.

So in the current low interest rate environment I subscribe to the mantra of: 1. keep it short (duration) to promptly take advantage of interest rate increases over time to better keep up with inflation; 2. keep it safe as in Gov’t guaranteed bank Deposits as opposed to Bond Funds / corporate bonds etc. Finally to further avoid inflation eating into interest bearing deposit returns try to hold these in the lowest tax environment available to you. In our case that equates to high interest cash and Term Deposits of less than 12 months (with 6 months being the preferred term af this time) held in the no / low tax Super Pension / accumulation environment.

In relation to the above linked article just last week even the author suggested that some caution might be warranted with bonds:

Shifting Risks in the Bond Market

Finally I dramatically favour equities over bonds / fixed interest in general. But as a retiree I feel it prudent to hold enough defensive assets to keep us out of trouble when equity markets tank or more importantly when dividends are cut.

As usual each investor needs to decide what’s best for them financially and psychologically.

 

Domestic and international isn't quite correct. US is about 60% of developed market. So the investor isn't necessarily going home country bias, they are weighting by market cap.

An Australian Weighing VAS and VGS as a US investor would weight VTS and VEU is totally different IMO even if there are valid reasons for doing so.

 

Good points. Even in the US Bogleheads can never agree on domestic vs international allocation. Then once you get into smaller markets like ASX the whole allocation issue becomes more difficult.

This is an entire subject in itself including topics such as home bias, local vs global currency exposure and introduction of hedging etc. A wonderfully interesting topic which I’ve been further reading about recently.

 

Thankyou for the reply, couldn't agree more.

 

What have you been drinking??


A few of these and I still struggle to stay interested

 

LOL. I was waiting for someone to say that. The strange thing is this occurred over two days last week when I decided to abstain from any alcohol. I think I must have been in a state of delirium during that time from abstinance hence perhaps my recollection of the reading experience was more imagined than real.

But rest assured I’ve seen the error of my ways and things are back to normal.

 

Speaking on Bogleheads... I was listening to their podcast (Yes they have their own podcast!) and they were interviewing the former CIO I think of Vanguard US and they asked him about asset allocation and home country bias and he surprisingly said that most people should have some level of home country bias and used Australia as an example saying we only represented 2-4% of global equity markets but AU investors in his opinion should not have 2-4% of their portfolio only invested in Aus because of the main reasons which have been raised here before currency fluctuations spending retirement funds in local currency...

 

What is the definition of ultimate portfolio? The one with the best return? Then buy something like Amazon at IPO.

The ultimate portfolio is one where you maximise your return whilst staying within your risk tolerance.