There’s a lot to like about Vanguard from an investment perspective. They have been innovative in driving adoption of low-cost, passive funds for individual investors.
Nonetheless, there’s a lot of ways to invest with Vanguard, so if you’re looking through their Exchange Traded Funds (ETFs), where’s the best place to start?
One of the best places to start on the stock side of things, is Vanguard’s U.S. Total Stock Market ETF. ETFs can be a good choice relative to mutual funds as they typically offer greater tax efficiency for investors. Vanguard’s ETF (VTI) costs just 0.04% a year in expense ratio, which means if you invest $10,000 for a year, you’re paying $4 annually in expense ratio costs. That’s not bad. Bear in mind Fidelity recently introduced two zero cost funds, and hence leap-frogged Vanguard on pricing for certain asset classes. Nonetheless, within the Vanguard fund offerings this is a compelling product.
The ETF gives you broad access to U.S. companies, holding over 3,000 individual names. So diversification is broad. Nonetheless, it is still market cap weighted, and this means it has disproportionate exposure to larger U.S. companies, with the top-ten holdings (Apple, Microsoft, Amazon.com etc.) representing 18% of the ETF’s exposure. This concentration is common in market capitalization weighted indices. As such it’s probably the best way to track the U.S. market with Vanguard.
As I’ve written before, there are good reasons why stocks and bonds work well together, they are the peanut butter and jelly of asset classes. Stocks can bring the growth, but bonds can offer stability. On the bond side Vanguard’s Total Bond Market ETF (BND) is again, a powerful way to access a broad set of different bonds at low cost. It holds over 8,000 different bonds, and again has a low expense ratio of just 0.05%.
Again you’re well diversified across different bond maturities and have some credit risk exposure, so you’ll end up with diversified U.S. bond exposure by owning this fund.
Shorter-term investing options
The above two funds can be sensible options if you’re investing longer term money. However, if you have a shorter-term time horizon, then Vanguard’s Short Term Treasury ETF (BSV) can be a good option. This will never shoot the lights out in terms of return, but it is offering a 2.5% yield with a low duration of 1.9 years. As a result it’s a stable place to put short-term money.
Though stock market investing can be great for the long-term it’s impossible to guarantee that the market won’t have a temporarily bad run for a few years, therefore, this is a prudent option for shorter term money. You could also consider the diversified bond fund above of course, though it carries a little more risk if rates rise faster than expected. And at the moment with a relatively flat yield curve, you aren’t getting paid that much to push out your bond exposure. You currently earn about an extra 0.5% a year all else equal for holding longer duration government bonds.
Finally, what could be a critical component of portfolios at a time when U.S. stock valuations seem stretched is international exposure. Interestingly enough, Jack Bogle, the founder of Vanguard is not a major advocate of international diversification. Nonetheless, at a time when U.S. valuations are high relative to longer term historical norms international diversification seems to make a lot of sense. There are a few ways to do this with Vanguard instruments, the Vanguard FTSE ex-U.S. ETF (VEU) is one way to do so. The expense ratio here is a little higher at 0.11% yet this is typically true of non-U.S. stock exposure, and the trade-off of a slightly higher expense ratio in exchange for less aggressive valuations and broader diversification appears worth it. The nice thing about building global stock exposure in this way is that you get to control how much exposure you have in the U.S. market and how much is international, whereas if you own a global fund, the relative weights are driven by market capitalization, which may not make sense for you.
Of course, Vanguard offer many other ETFs than discussed above. Does that mean the other ETFs are bad? No, the choices here focus on the primary asset classes you need for portfolio construction. The other ETFs Vanguard offer can be useful, but can be more focused and offer less diversification benefit. For example, Vanguard offer a long-term bond ETF, but owning it may mean you’re taking more risk on the future direction of interest rates than you need or want to. Vanguard also offer ETFs for specific regions or sectors of the economy, such as European stocks or financial companies. These sorts of funds will generally be less diversified than picking a broad ETF that spans sectors and countries. You can own these more focused funds, if you want to express a view on a particular part of the broader investment universe. However, for the buy and hold long-term investor, owning broad, diversified funds is both a good place to start, and a fine place to finish as well.
Starting in the wrong place
Finally, remember though the question is often asked, which funds should I buy? That’s actually the wrong question to be asking when you start your investment process. The first thing is to make sure that you have a robust investment plan in place. Only then will you know what asset classes you are interested in, and that’s when fund selection, from Vanguard or somewhere else, comes into play. The recommendations here generally assume longer term, buy and hold investing, with the exception of the short-term government bond fund, which is a place to park short-term money and cut risk.
It’s also worth knowing that unlike dining room chairs or luggage, the ETFs in your portfolio don’t need to match. Yes, Vanguard do have many strengths, and you can do worse than construct a portfolio from only Vanguard funds. Nonetheless, if there’s another fund that’s similar and perhaps cheaper in expense ratios terms of offered commission-free then it’s fine to buy an iShares, Fidelity or Schwab product.
Bear in mind that most mainstream ETFs are rules-based products, so are relatively easy to set up and maintain without much ongoing investment decision-making. They are generally tracking very similar index, so the chance of one provider materially beating another on passive ETF performance in a similar category is low. I imagine Vanguard will continue to innovate and out their customers first if history is any guide, but blindly buying their products if there are more appropriate options out there at lower cost can be unhealthy too.
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