Index Fund Strategy

I want to start an Index Fund strategy for my portfolio. I currently have my investments at Fidelity but am not adverse to switching my retirement funds to another company if it is more advantageous in the long run. The only cost would be $50 per account type to take it out of Fidelity. I am considering two strategies.

The first is proposed by the book "The Coffeehouse Investor" by Bill Schultheis. He recommends either a 3 or 5 Index Fund approach.

3 Fund Approach
Large Company Stocks
International Stocks
Small Company Stocks

5 Fund Approach
Large Company
Large Company Value
Small Company
Small Company Value
International and REITs

The second approach is proposed by the book "The Four Pillars of Investing" by William Bernstein. It is more diverse but will take years to fully realize and will be difficult to implement at Fidelity because of the high minimum requirements for their Index Funds (many start at $10k). I am considering the following approach from the book.

12% Vanguard 500
15% Vanguard Value
3% Small-Cap
9% Small-Cap Value
6% REIT
1.8% Precious Metals
3% European
3% Pacific
3% Emerging Markets
4.2% International Value
40% Cash, Bonds

There is a detailed spreadsheet in the book that shows what to purchase each year based on the maximum IRA annual contribution amounts.

My concern with the first approach is it is not diversified enough. He doesn't even include Bonds. My concern with the second approach is that it is difficult to implement with small amounts (approx 50k in retirement funds).

Any feedback appreciated.

My advice is a 2 fund portfolio in a 50-50 split:

1) Vanguard Balanced Fund
2) Vanguard Total International FTSE Ex-US

Rebalance once every few months back to 50-50 split. With these two funds you will be 20% Total US Bond Market, 50% International Stock Market, and 30% US Total Stock Market.

80-20 Equity Bond split
40-60 US International Equity Split

tripleB, Interesting strategy. I'll look into that. Is there a reason you prefer International or are you trying to keep it as close to 50 50 as possible?

scrouds, I'm looking at 30 years.

FWIW, I'm about 30+ years ahead of you (I retired 3 years ago, at 57). I'm also a big fan of Bernstein, Bogle, etc. I like to keep things relatively simple, so I've limited my equities to SP500, Extended Market (small and mid cap, everything but the biggest 500), MSCI EAFE, int'l emerging markets, and a smattering of REIT (US and int'l). I stay away from bonds, and instead put my cash in a variety of FDIC-insured accounts and CDs.

I have all my equity investments at Fidelity (after-tax brokerage, IRA, Roth IRA) and have been very pleased. I know that Fidelity has high minimums for their index funds, but you can start out with one or two then add others when your balances get high enough. Fidelity's index funds cover most of the major asset classes: SP500, Total Mkt, Extended Market, MSCI EAFE. The one asset class I really wanted that Fidelity didn't offer was int'l emerging markets, and for that I bought the Vanguard VWO ETF from within the Fidelity brokerage account.

One thing that I really like about Fidelity, and which made me choose them over Vanguard about 15 years ago, was that they serve as a great financial hub. My Fidelity brokerage account serves as my primary checking account, and it's easy/fast to move money around.

I'm a simple fell'a:

VBINX
VASGX

50/50

Given your long time frame, the expense ratio of the funds makes a big difference. For the major index funds, for the dollar amounts you're discussing, Fidelity's funds are much cheaper than Vanguards. (E.g., Fidelity Spartan Total Market Index Fund - Investor Class at 0.10%/year, vs. Vanguard Total Stock Market Index Fund Investor Shares at 0.18%). Frankly, even that small cost differential will likely help you more than the strong value bias created by Bernstein's overcomplicated structure, meaning that you're likely better off choosing fewer funds that you can hit the $10K minimum for.

I would steer far away from the iShares ETFs. Their expense ratios are much higher than either Fidelity's or Vanguard's regular mutual funds, making them a poor choice for someone who might hold to them for 30 years. The free commissions are a false economy for a long-term investor.

Remember that there's also no commission charge to buy Fidelity funds in a Fidelity account. Once you've opened the account with the $10,000 minimum, you can add to those positions in any amount.

I would definitely check out the Bogleheads forum. They highly recommend Vanguard for your investments due to the low expense ratios of their index funds but could help you put together a portfolio.
Yeah, they recommend Vanguard because they're such a Vanguard fan club that they refuse to poke their heads out of the sand and see that Fidelity has lower cost funds. That's true whether you're comparing the "Investor" shares or the cheaper classes that have $100K minimums ("Advantage" at Fidelity and "Admiral" at Vanguard).

tolamapS,
Short-term Corporate in a taxable account.

UncaMikey,
Thanks for sharing your personal experiences with Fidelity. I have been using them for the same reasons. Would you mind sharing your diversification mix? What percentages do you allocate to each fund?

sage1166,
Thanks for pointing me to that resource. I'll definitely check them out.

ThePessimist,
Good point about the fees. I'll try to reduce the number of funds to see if I can come up with a different mix.

Thanks again for all the good feedback. Am I correct in saying that it seems like most people recommend the 5 fund approach?

EDIT:
standardtoaster,
You posted while I was typing this. Thanks for the detailed information. I'll definitely check out those resources. You are correct, I want a lazy portfolio.

VTI, Vanguard Total Stock Market Index ETF. Gives you large cap, small cap, everything (U.S. only though). 0.09% expense ratio, which is tough to beat.

standardtoaster said: What you're creating seems to be called a "lazy portfolio." The first step is to decide your bond/stock/cash split, then decide how to diversify.

Here are a few lazy portfolio links which include the Coffeehouse portfolio and similar ones:

The Oblivious Investor - 8 Lazy ETF Portfolios

MarketWatch - Lazy Portfolios (in terms of mutual funds, but there are equivalent ETFs for each)

Bogleheads - Lazy Portfolios

Everyone (including Buffet) is bullish on ETFs, so you should definitely consider them. You can even invest in bonds through ETFs. A great primer on ETFs is Seeking Alpha's ETF Investment Guide. (There's also a one-page summary -- it's a lot of material.)

With ETFs, it's pretty easy to choose your comfort level of diversification -- pick a whole index, like the entire US Stock Market (e.g., VGI), or get as specific as you want, like US crude oil (USO). Note that, as the index that the ETF follows gets broader, the expense ratio gets lower.

If it helps, another good search term is "asset allocation."

Disclosure: My allocation is 20%/75%/5% bond/stock/cash, and bonds and stocks are in ETFs.

I skimmed through your links and, please correct me if I am wrong, it seemed to me that the recommendations for ETFs were slanted towards taxable accounts due to their tax advantages.

HERE and the second comment HERE.

Are you using ETFs for the sheltered portion of your portfolio, the unsheltered portion, or both? How often do you re balance? Can you please explain your analysis of the cost versus the gains on one of your ETFs versus the mutual fund counterpart?

Thanks!

EDIT:
Another data point. The articles about ETFs mention lower expenses versus Index Funds, but the one I linked to above compares Vanguard's Index funds at 0.18% versus their ETFs at 0.09%. If you take into account Fidelity's Index Funds at 0.10% this advantage goes away.

I've posted my opinion that ETFs are a very bad idea for regular investors (other than day traders) compared to regular mutual funds several times before, and most of the time I just get red, without anybody ever attempting to refute my arguments. Everyone is so brainwashed by the ETF marketing (which I admit is brilliant)?

Just ask yourself these questions: is the ETF share price determined by supply and demand of the ETF itself, or the NAV of the underlying securities? By what mechanism are the two related?

From the ETF premier mentioned earlier in this thread:
A 1-Page ETF Primer said: An important feature of ETFs is that financial institutions can exchange ETFs for the underlying assets they represent with the issuing institution for a small fee. This feature prevents ETFs from trading at systematic discounts or premiums to the value of the underlying assets of the fund. If, for example, an ETF trades at a premium to the value of its underlying assets, a smart institution will sell the ETF short and buy the basket of underlying stocks which it will then exchange for the ETF at actual value, thereby making a profit. The possibility and occurrence of this arbitrage prevents a gap opening between the traded price of the ETF and its net asset value.

So you buy an Am.Ex ETF at Ameritrade, Ameritrade sees an arbitrage opportunity and trades your ETF shares for the underlying securities with Am.Ex. Ameritrade and Am.Ex both profit. Where did their profit come from? Why, the ETF investors, of course! And this is a cost of investing in ETF that's not shown anywhere in the prospectus or expense ratios, so direct comparisons of ETF and regular MF expense ratios are bogus -- with regular MF (open-ended only!) the expense ratio is your true measure of overhead, but not so with ETFs.

You may say that any trading has this hidden cost of someone else making money on arbitrage, at your expense. And you'd be right. There are many very profitable trading companies doing just that, and their income comes from suckers like me (and probably you) who aren't exploiting these arbitrage opportunities (I shouldn't complain too much, as my wife is working at a trading company, so we all are paying her salary this way). But rarely are there such obvious and no risk arbitrage opportunities with other instruments as with ETFs (which the financial industry just created out of thin air for itself!); and trading ETFs you're subject to these negative effects TWICE! (The ETF itself, AND the underlying securities.) Not so with regular MFs.

olegos said: I've posted my opinion that ETFs are a very bad idea for regular investors (other than day traders) compared to regular mutual funds several times before, and most of the time I just get red, without anybody ever attempting to refute my arguments.

Start a thread called "ETFs really aren't as good as mutual funds" and I'll be sure to up-vote it.

standardtoaster said: Agent9: I lied a little. I haven't actually invested my funds yet, but I'm approaching the tail end of a few weeks of research. I'm planning on holding these funds for 3-5 years, maybe longer. I'm not an expert.
Ah. We're in the same boat.

Using the formula you linked to, compare 0.09% and 0.18% with a $50k initial investment, minus $10 trade commission, expecting 10% returns, over 5 years:

(50000 - 10) * (1 + 0.10 - 0.0009) ^ 5
80180.57

(50000 - 10) * (1 + 0.10 - 0.0018) ^ 5
79852.83

Thus, the 0.09% wins by a little bit. But, there's more it that -- dividends, bid/ask spreads, capital gains due to the fund trading. Motley Fool's article on Mutual Funds vs. ETFs is somewhat useful, but there must be better info out there.

Of course, I've probably made some terrible embarrassing blunder, and I encourage other FWFers to drag me through broken glass.
Thanks for posting your calculations. It gives me a better idea. No load funds don't have the $10 trade commission. Fidelity Index Funds have 0.10% expense. My sheltered accounts will not have to pay capital gains until I retire. These reasons may wipe away the benefits of ETFs for my purposes.

standardtoaster said: What you're creating seems to be called a "lazy portfolio." The first step is to decide your bond/stock/cash split, then decide how to diversify.

Here are a few lazy portfolio links which include the Coffeehouse portfolio and similar ones:

The Oblivious Investor - 8 Lazy ETF Portfolios

MarketWatch - Lazy Portfolios (in terms of mutual funds, but there are equivalent ETFs for each)

Bogleheads - Lazy Portfolios

Everyone (including Buffet) is bullish on ETFs, so you should definitely consider them. You can even invest in bonds through ETFs. A great primer on ETFs is Seeking Alpha's ETF Investment Guide. (There's also a one-page summary -- it's a lot of material.)

With ETFs, it's pretty easy to choose your comfort level of diversification -- pick a whole index, like the entire US Stock Market (e.g., VGI), or get as specific as you want, like US crude oil (USO). Note that, as the index that the ETF follows gets broader, the expense ratio gets lower.

If it helps, another good search term is "asset allocation."

Disclosure: My allocation is 20%/75%/5% bond/stock/cash, and bonds and stocks are in ETFs.

What is that even supposed to mean? ETFs by themselves are not an asset class - they are an investment vehicle.

Conceptually, there is no difference between an ETF that passively tracks SP500 and a mutual fund that passively tracks SP500.

There are differences in terms of (a) tracking error, (b) fees, and (c) tax consequences, which could be substantial. But those same differentiating points can be made when comparing two mutual funds.

Can someone please point out the expenses for the iShares Emerging Markets (EEM) at Fidelity? I can't seem to find that information. Here's the link.

LINKY

Thanks for the link. 0.72%? Isn't that very expensive compared to Index Funds at 0.10%? Or am I missing something?

Using Allan Roth's Second Grade Portfolio I came up with this mix from Fidelity.

10% Fidelity US Bond Index Fund (FBIDX) 0.38% expense, currently capped at 0.32%
60% Spartan Total Market Index Fund (FSTMX) 0.10 % expense
30% Spartan International Index Fund (FSIIX) 0.20% expense, currently capped at 0.10%

With the 10k minimums I plan to start off with 10k FSTMX and 10k FSIIX and add to FSTMX every year until I have 40k FSTMX then add to FSIIX until I have 20k then add FBIDX 10k.

10k Fidelity US Bond Index Fund (FBIDX)
40k Spartan Total Market Index Fund (FSTMX)
20k Spartan International Index Fund (FSIIX)

Now I add to FSTMX to get to 60k then FSIIX to get to 30k. Thoughts?

Any feedback?

Agent9 said: Using Allan Roth's Second Grade Portfolio I came up with this mix from Fidelity.

10% Fidelity US Bond Index Fund (FBIDX)
60% Spartan Total Market Index Fund (FSTMX)
30% Spartan International Index Fund (FSIIX)

With the 10k minimums I plan to start off with 10k FSTMX and 10k FSIIX and add to FSTMX every year until I have 40k FSTMX then add to FSIIX until I have 20k then add FBIDX 10k.

10k Fidelity US Bond Index Fund (FBIDX)
40k Spartan Total Market Index Fund (FSTMX)
20k Spartan International Index Fund (FSIIX)

Now I add to FSTMX to get to 60k then FSIIX to get to 30k. Thoughts?

My opinion doesn't matter since I'm a noob, but some other things to consider:

• How old are you? I'm guessing mid-twenties with such a low percentage of bonds.
  
• Also consider whether it makes sense to add an emerging markets fund
  
• Are we to assume that you're not going to need this money for at least 5 years? What about a rainy-day stash?
  

Noob question.. Given the current state of the residential real estate market and the oft quoted coming comercial real estate trouble...are REITs an asset class worth investing in now, or waiting on, and if you think "now" what do you look for in evulating an individual trust's financials.

Agent9 said: Any feedback?

One warning, if your balances drop below the $10k, you will have to pay a fee to Fidelity.

www.vanguard.com - free for Vanguard funds
www.schwab.com - free for Schwab funds and ETFs
www.wellstrade.com - 100 free trades per year for all of the above if you have $25k