“Simplicity is the master key to financial success. When there are multiple solutions to a problem, choose the simplest one.” – John Bogle, Founder of Vanguard
One of the most overwhelming parts about the investment process is the fact that there are so many choices that you have to make just to get started. You have to open up the correct accounts, determine how much to save and set your asset allocation before you even begin to figure out what to invest in. But once you get through all of those steps you do have to actually decide what investments to put in your portfolio.
There are three main criteria you need to create a common sense investment portfolio. They are as follows:
1. Diversification: The best reason to have a diversified portfolio is that no one can predict the future, especially in the investment world. Staying diversified means you are willing to admit you don’t know what sector or market will outperform in a given investment period so you cover all of your bases. Some investments will do better than others under different environments. Diversification will make your ride less bumpy along the way. It won’t always work in the short-term but over the long-run it is the simplest way to get desired results without the risk of losing it all.
2. Low Costs: Costs (both transaction fees and expense ratios) can really add up over an investment time horizon that can stretch anywhere from 40 to maybe even 65 years or more in some cases depending on when you start. Keeping them low is one of the best investment moves you can make.
3. Easy to understand: This will require a low number of funds in simple strategies. The more complex an investment is the easier it is to get taken advantage of by greedy Wall Street types. Less is more.
You can open an IRA (traditional or Roth) or brokerage account through both of these companies and buy ETFs with no transaction costs (learn more about ETFs). I’m going to give you two very simple portfolios that you can create through both Vanguard and Charles Schwab using ETFs.
Since I don’t know your personal risk profile and time horizon it’s difficult to give advice on how to allocate between the funds (learn more about asset allocation). Therefore I’m going to give you my baseline recommendations that will give you a starting point to then make corrections based on your situation and investment preferences.
Here is common sense portfolio #1 shown separately for each fund provider (with corresponding tickers and expense ratios):
And here is common sense portfolio #2:
Vanguard Common Sense Portfolio #2
Large-Cap Stocks (VV – 0.10%)
Mid-Cap Stocks (VO – 0.10%)
Small-Cap Stocks (VB – 0.10%)
Emerging Market Stocks (VWO – 0.18%)
MSCI EAFE International Stocks (VEA – 0.12%)
Total Bond U.S. Market (BND – 0.10%)
Charles Schwab Common Sense Portfolio #2
Large-Cap Stocks (SCHX – 0.04%)
Mid-Cap Stocks (SCHM – 0.07%)
Small-Cap Stocks (SCHX – 0.08%)
Emerging Market Stocks (SCHE – 0.15%)
International Stocks (SCHF – 0.09%)
U.S. Aggregate Bond Market (SCHZ – 0.05%)
Emerging Market Bond Market (PCY – 0.50%)
As a starting point for these portfolios use a 50/50 mix of stocks and bonds as the baseline for being risk averse and a 100% stock allocation as being very aggressive on the risk spectrum. You can then make changes to your allocation between stocks and bonds based on your willingness and ability to take on risk.
For the stock portion of the portfolio start with an even mix between the funds as the baseline and make any necessary corrections from that starting point. You can use the assumption that mid-cap, small-cap and emerging market stocks will be more volatile in the short to intermediate term and can therefore be seen as having more risk than the large-cap or international market options (this has been the case historically).
(Quick sidebar: For what it’s worth, the U.S. stock market makes up about 45% of the world stock market. Fortunately most companies in the S&P 500 (large-cap) are global and make their money around the world. Most advisors recommend 30-40% in international funds but you need to go with what makes you comfortable.)
For bonds a simple total market fund will do. You get diversification between many difference types of bonds (government, mortgage and corporates). For the Charles Schwab ETFs there is an emerging markets bond option so I included that for diversification purposes in the second set of ETFs. It does have a higher yield which means higher risk but it’s another way to spread your bets both geographically and within the asset class. Vanguard does not currently have an emerging market bond ETF.
Portfolio #1 is very simple and gets you the entire market in three fund choices. The reason I like to add a few more funds to the mix in Portfolio #2 is that you will see more separation between the returns in the fund, allowing you to rebalance to take advantage of opportunities in the various markets.
Whichever portfolio you do choose make sure you rebalance back to your target weights that you choose for asset allocation purposes. You do not want to let your mix of assets get too far away from your target weightings because that would defeat the purpose of figuring out your risk tolerance and making an investment plan.
For those looking to get a deeper dive in their portfolio you could add a few more funds. These are two simple options for your portfolio. If you really want to diversify further and make other changes to your risk profile you can add dividend stocks, REITs, commodities or other bonds investments like TIPS or high yield debt. Just remember to not make it so complex that you can’t keep track of everything and manage your portfolio.
The goal is not to pick the absolute perfect blend of investments. That will be impossible and change from year to year. The goal should be to pick the portfolio mix that gives you the best chance of achieving your long-term goals without making behavioral errors of judgement along the way.
There a couple of caveats for these ETF portfolios. ETFs trade just like stocks when the market is open so you are free to buy and sell them all day (unlike mutual funds which are bought and sold only at the close of the market). Do not use this feature as a temptation to make short-term moves. The best way to utilize a common sense portfolio is through long-term investing, not short-term trading.
This also means that there is no way to set up automatic investments for ETFs (it’s only a matter of time but you can’t do this quite yet). So if you have trouble saving on a regular basis and want to make it automatic take a look at the corresponding index mutual funds since you can automate those contributions. They give you the same investments only with a slightly higher cost. One way I have found as a work around for this problem is to invest in the mutual funds automatically and then convert them on a periodic basis to the ETF version. Vanguard does this free or charge.
If you have a retirement account open through another provider or your employer’s retirement plan, simply look at the Vanguard and Charles Schwab fund descriptions and try to match them with your fund line-up. You can create your own common sense portfolio using the funds that are available to you.