Tag: personal finance

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Stocks and Bonds in an ETF portfolio over the long-term

Stocks and bonds carry many benefits when held over the long term. In this post, I highlight a few aspects that are important to individual investors.

Two of the largest stock and bond ETFs analyzed each month by ETFMathGuy follow the tickers symbols IVV and AGG. IVV tracks the S&P 500 index, which consists of large U.S. companies. The top 10 holdings of IVV appear below.

Top 10 holdings of the iShares Core S&P 500 ETF. Source: etf.com/ivv
Top 10 holdings of the iShares Core S&P 500 ETF. Source: etf.com/ivv

The ticker symbol AGG tracks the Bloomberg Barclays U.S. Aggregate Bond Index. As we discussed in our previous post on the “Fundamentals of Fixed Income ETFs“, quality and maturity are two important components. The quality component of this ETF is largely influenced by its 40% of holdings of U.S. government bonds, and over 20% of mortgage backed securities. Top sector holdings appear below.

Top 10 sector holdings of the iShares Core U.S. Aggregate Bond ETF . Source: etf.com/agg
Top 10 sector holdings of the iShares Core U.S. Aggregate Bond ETF . Source: etf.com/agg

The bonds in AGG have an average maturity of about 8 years. Consequently, interest rate changes generally affect its price more than similar bond ETFs with shorter maturities.

Long term returns of stocks and bonds

The fundamental information about stock and bond ETFs is important, but doesn’t really address long-term investment performance. For that, consider the following chart that shows the total return of $100,000 invested in either the stock (green) or bond (blue) ETFs mentioned previously.

Total return of $100,00 invested in IVV (green) and AGG (blue) from January 5, 2004 to July 19, 2019. source: ETFReplay.com
Total return of $100,00 invested in IVV (green) and AGG (blue) from January 5, 2004 to July 19, 2019. source: ETFReplay.com

As this chart shows, much better returns are possible with stocks, provided investors are willing to accept the higher volatility. Annual growth rate of the stock ETF (IVV) is more than double (8.7% versus 4.0%) than the bond ETF (AGG). But, the volatility of the stock ETF is nearly four times (4X) larger than the volatility of the bond ETF.

Asset allocation basics

So, what is the correct allocation between stocks and bonds using ETFs? Generally speaking, investors seeking less risk will seek more bonds and less stock exposure. One simple rule of thumb is the “120-age” formula for stocks. So, a 30-year old investor would be 90% in stocks and 10% in bonds. Similarly, an 80-year old investor would be 40% stocks and 60% bonds. A more conservative approach is the “100-age” formula for stocks. In any case, investment risk typically increases with a higher allocation to stocks, and decreases with a higher allocation to bonds.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
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July 2019 optimal portfolios are now available and discussed in terms of recent and long-term market trends

The July 2019 optimal portfolios are now available to subscribers of ETFMathGuy. So, please log in and select your discount broker. In this post, we will also discuss more about risk and return in an optimal ETF portfolio.

As we mentioned in our last post, there are benefits to having more ETFs to choose from during the portfolio construction process. We showed the potential to increase expected returns. In this post, we highlight another important element – risk.

Risk and Return

Risk and return are two fundamental issue that are important to consider when investing in an ETF portfolio. The chart below shows risk (horizontal axis) and return (vertical axis). Here, we define risk as the annual volatility, measured by the standard deviation of daily returns. We evaluate risk and return using a multi-year sample period selected from our rigorous backtesting process. As this chart shows, the optimal portfolios reside at risk levels between the bond market (ticker: AGG) and stock market (ticker:IVV). And, these portfolios are efficient, since they were selected to maximize the expected return.

Risk (Volatility) and Expected Return in the July 2019 optimal portfolios. Notice that at each risk level (conservative, moderate and aggressive), different ETFs offered by different discount brokers leads to different expected returns.
Risk (Volatility) and Expected Return in the July 2019 optimal portfolios. Notice that at each risk level (conservative, moderate and aggressive), different ETFs offered by different discount brokers leads to different expected returns.

As this chart shows, cash can be nearly risk-less, based on volatility, but offers returns that may not exceed long-term inflation. Bonds can offer more of a potential return, but with added risk. Even more return is possible from the stock market for those willing to accept additional risk.

What about the last 6 months?

Indeed, it is true that the first half of 2019 has been very good for both stocks and bonds. Based on a recent Wall Street Journal article, “… S&P 500 finished Friday up 17% this year, marking its best first half since 1997 “. According to the site ETFreplay.com, and including dividends, the stock and bond market are up 18.3% and 5.8%, respectively, this year. Will this trend continue? I personally doubt anyone really knows, as I believe that markets are generally very efficient. A better question may be “What level of risk” or “How much exposure” do you want your investments to have in various parts of the market. To end this post, I’ll leave you with one (of many) famous quotes by Warren Biuffet.

“The stock market is a device to transfer money from the impatient to the patient.”

Warren Buffett

We hope you found this post educational!

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
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Risks and Opportunities in Fixed-Income ETFs

Fixed-income ETFs (also known as bond ETFs) continue to grow at a rapid pace. Bond ETFs now exist across a wide spectrum of characteristics. Looking for shorter or longer maturity? Or, how about higher yield (aka junk bonds) versus investment grade or Treasury bonds? ETFs even cover the bond markets in both emerging and developed economies worldwide.

At this rate, State Street Global Advisers predicts that assets in bond ETFs could reach $1 trillion by the end of 2019.

What is driving demand?

Like stock-based ETFs, low cost is a big driver. Greater tax efficiency, as we discussed in detail in a post earlier this year, over bond mutual funds helps too. But, the biggest demand could be simply choice.

“Investors really have a lot of choices — more than they’ve had in the past five years. “

Noel Archard, State Street Global Advisors

Liquidity concerns?

Our opinion at ETFMathGuy is that liquidity concerns are minimal. In fact, real-time ETF price availability helps the price discovery process, and should improve liquidity.

“Fixed-income ETFs have been tested more than once over the past 10-11 years, without any major issues. “

Rich Powers, Vanguard

The current focus of fixed-income ETFs

The current focus of fixed-income ETFs is now in portfolio construction. Here at ETFMathGuy, we are helping to lead this initiative by building portfolios to take full advantage of what fixed-income ETFs have to offer. For instance, in the May taxable conservative portfolio for Vanguard, we show a portfolio with a a variety of fixed-income ETFs in it. We also seek to include higher volume alternative ETFs, to mitigate any possible liquidity issues and minimize the bid-ask spread trading costs.

May 2019 taxable optimal portfolio for risk conservative investors, by ETFMathGuy.
May 2019 taxable optimal portfolio for risk conservative investors, by ETFMathGuy

In conclusion, fixed-income ETFs are in important core component of an optimally diversified portfolio. We invite you to browse through the current month optimal portfolios to see the importance of bond ETFs.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
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Discount brokers adjust and expand their commission-free ETF lineup

A few weeks ago, we discussed the expanded commission-free ETF lineup offered by Fidelity and Schwab.

In this post, we revisit the current commission-free ETF lineup offered by the three other discount brokers analyzed by ETFMathGuy. These three brokers include Ameritrade, ETrade and Vanguard.

Ameritrade’s updated lineup of commission-free ETFs

Ameritrade continues to offer 308 commission-free ETFs. Our list used to develop optimal portfolios at ETFMathGuy at the end of last year did change somewhat. Seven ETFs ceased trading in February and March, and most were from WisdomTree.

Seven ETFs ceased trading in February and March, 2019, and were removed from Ameritrade's commission-free ETF lineup.
Seven ETFs ceased trading in February and March, 2019, and were removed from Ameritrade’s commission-free ETF lineup.

Ameritrade replaced these ETFs with seven commission-free ETFs. These replacements come from First Trust, State Street, iShares and Invesco.

Ameritrade added seven funds to their commission-free ETF lineup.
Ameritrade added seven funds to their commission-free ETF lineup.

ETrade’s updated lineup of commission-free ETFs

ETrade made a modest increase to their commission-free ETF lineup, increasing from 259 to 274. Their lineup change was due to removing a number of funds from Vanguard. In addition, and like Ameritrade, many of these ETFs from JPMorgan, Legg Mason and WisdomTree ceased trading.

Fourteen ETFs removed from ETrade's commission-free ETF lineup.
Fourteen ETFs removed from ETrade’s commission-free ETF lineup.

The additional commission-free ETFs offered by ETrade come from a variety of ETF providers, such as Invesco, WisdomTree, iShares and others. The real question here is will these new funds be around for the long haul.

Etrade's commissoin-free ETF lineup includes 29 additional funds.
Etrade’s commissoin-free ETF lineup includes 29 additional funds.

Vanguard’s updated lineup of commission-free ETFs

Vanguard made the smallest change to their list of commission-free ETFs, adding only two funds. Consequently, Vanguard’s total lineup increased from 57 to 59, and embraces a new trend in Environmental, Social and Governance (ESG) investing.

Vanguard expands their commission-free ETF lineup.
Vanguard expands their commission-free ETF lineup.

So what does this mean for an individual investor?

So what this means to an individual investor? A larger number of commission-free ETFs should provide a greater opportunity for diversification and possibly higher returns. Evidence for this appears in the expected returns and volatility estimates in the latest portfolios developed by us at ETFMathGuy. However, what if you are an investor who had invested in one of the ETFs that ceased trading? An article claims that the liquidation process is mostly painless for the investor. It also claims that even if you don’t sell the ETF before it ceases trading, “you are still going to get fair value for the fund based on the final liquidation”. The bigger issue is how removal of the ETF affects your asset allocation and underlying strategy. If you are following the current portfolios at ETFMathGuy, we have already updated our databases to accommodate such a change.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
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April 2019 Optimal Portfolios are Now Available to ETFMathGuy subscribers

The 2019 optimal portfolios for the month of April are now available to subscribers of ETFMathGuy. Just log in and select your discount broker.

You can now view the current portfolios for the five discount brokers analyzed by ETFMathGuy. These portfolios cover over nearly 1,500 ETFs currently offered commission-free from Ameritrade, ETrade, Fidelity, Schwab and Vanguard.

What’s new? Full ETF names, portfolio & benchmark statistics, and portfolios for taxable and IRA accounts.

So, what’s new this month? First, we’ve added the full name of the ETF, so that subscribers don’t need to look up individual ticker symbols. For instance, the portfolios continue to favor the utility sector. So, for example, the Vanguard portfolio lists both the ticker “VPU” and its full name, “Vanguard Utilities ETF”, in the portfolio tables.

New information available on 2019 optimal portfolios from ETFMathGuy
New information available on 2019 optimal portfolios from ETFMathGuy

Second, we’ve added portfolio annualized statistics for expected return and volatility. Now, it is clear what the risk levels are set to in portfolio construction, regardless of the discount broker. For the month of April, annualized risk levels were

  • Conservative: 5.7%
  • Moderate: 8.3%
  • Aggressive: 11.0%

Third, we’ve added benchmark statistics. These measures are an excellent way to understand how the optimal portfolios match up to the broad stock, bond and cash benchmarks used by ETFMathGuy.

Last, but not least, we’ve run our portfolio construction process to include and exclude municipal bond ETFs. As mentioned in our recent post, brokers like Fidelity often restrict the use of municipal bond ETFs in IRA accounts. The summary table at the top of the current portfolios now indicate either Taxable or IRA (no munis).

We hope you find these 2019 optimal portfolios insightful and educational! If you enjoyed reading this post, we hope you will share it with others in your personal or professional network. Just click one of the icons below. And, for a limited time, subscriptions are free!

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.

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Discount brokers expand their lineup of commission-free ETFs

Last month, Fidelity and Schwab announced an expansion of the commission-free ETFs offered to their customers. We touched on this point in a recent ETFMathGuy Blog post. But, we didn’t get into much of the details of what an expanded lineup of commission-free ETFs would mean for an investor. So, in this post, we will dig into some of cost details, like expense ratios and bid-ask spreads.

Fidelity’s expanded list of commission-free ETFs for 2019

The announcement on February 12, 2019 indicated over 500 commission-free ETFs. As a current Fidelity customer, I was delighted to see the expansion. Unfortunately, as of March 16, 2019, Fidelity’s ETF screener revealed only 357 ETFs as commission-free. Note that this screen is only available to current Fidelity customers.

Fidelity's commission-free ETF list, as of March 16, 2019 reveals 357 funds available.
Fidelity’s commission-free ETF list, as of March 16, 2019.

Given the strong reputation Fidelity has in the investment community, I am sure they will follow through soon with their fully expanded lineup of more than 500 commission-free ETFs. However, it is unfortunate that Fidelity’s press release didn’t give a specific timeline for when the fund expansion will occur in its entirety, except to say “…in the coming months”.

Schwab’s expanded list of commission-free ETFs for 2019

Schwab now claims 500+ commission free ETFs. We downloaded the list of Scwhab’s expanded commission-free ETFs, and found exactly 500. So, we are not sure where the “+” comes from, but this is still quite a large lineup.

How do the expense ratios compare?

Expense ratios are important, as they are a continuous drag on returns. So, ETFs with lower expense ratios than others tracking the same index should produce higher returns. Using data obtained from ETF.com, we created charts to show a histogram of expense ratios for the commission-free ETFs from Fidelity and Schwab.

Expense ratios for Fidelity's commission-free ETFs are generally lower than those from Schwab
Expense ratios for Fidelity’s commission-free ETFs are generally lower than those from Schwab.


What does this data show us? Generally, expense ratios are lower for Fidelity’s commission-free ETFs. But, there are quite a few (about 20% or 1 out of 5) of Fidelity’s commission-free ETFs with an expense ratio between 0.4% and 0.5%. So, with a little careful selection, Fidelity offers a larger fraction of commission-free ETFs at lower expense ratios then Schwab.

How do the Bid-Ask spreads compare?

Bid-ask spreads are the costs incurred when an ETF is bought or sold, and which I discuss at length in my article “Is there a free lunch in commission-free ETFs?“. Once again, using data from ETF.com, we see that nearly 80% of the commission-free ETFs from Fidelity have spreads below 0.2%. This compares to about 74% of funds from Schwab that have spreads below 0.2%. Thus, Fidelity’s commission-free ETFs have generally lower spreads then those offered by Schwab. So, for more active investors, Fidelity’s commission-free ETFs appear to have the advantage of lower transaction costs.

Bid-ask spreads from Fidelity's commission-free ETFs are generally lower than those from Schwab.
Bid-ask spreads from Fidelity’s commission-free ETFs are generally lower than those from Schwab.

Conclusions

Competition for investor assets continues, to the benefit of investors using commission-free ETFs. In this post, we discussed some of the details of the updated lineup of commission-free ETFs now offered by Fidelity and Schwab. We find that while Schwab still offers more ETFs commission-free, Fidelity’s costs are generally lower. Lower expenses are important, as they can often lead to higher returns for funds tracking similar indices.

Thanks for reading!

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.

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Passive investment funds aren’t guaranteed to beat their active counterparts

In this week’s WSJ article, an excellent discussion on was given on active versus passive fund performance around the world. Fund performance over 5 and 10 year periods show that, while passive investments are superior in most of the world, there are some pockets where active management did better.

Excess performance is country specific.

As I’ve highlighted in this table, U.S. stock funds investing in small, medium and large companies consistently underperformed their passive counterparts. These results help explain why index funds, and ETFs in particular, have become so popular in recent years.

The article also highlights another sad reality of active fund investing.

“…most active managers exhibit little ability to consistently beat their peers over time. “

Derek Horstmeyer, Wall Street Journal, March 3, 2019

So, what can we learn from this article?

Passive investments using ETFs don’t guarantee excess performance over their active counterparts. But, more times than not, passive investing will outperform active investing. This fact may not always be true outside the U.S., but for investors that primarily consume with U.S. dollars, passive investments in ETFs appear to be a clear winner.

Thanks for reading!

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Your Retirement Nest Egg

In a recent issue of the Wall Street Journal, there was an excellent retirement article. In it, the author responded to a reader’s question “How much does my nest egg need to be?”. Your retirement nest egg is very important! So, we prepared a summary and some additional insights to consider. Our perspective is drawn, in part, from our award-winning research on retirement income planning.

retirement nest egg

Article summary by ETFMathGuy

The article starts with predicting your expenses. This is arguably a difficult task, and where many people stop. But, without this information, there is really no way to estimate the “right size” of a retirement nest egg.

In summary, the article suggests the following calculation.

  1. Start with an estimate of your expenses. A common approach to this is to assume a percent between 60-80% of expenses pre-retirement. This approach assumes that your expenses go down in retirement. That may be true for many retirees, as they no longer have mortgage payments or dependent expenses. Of course, a more precise estimate can be done.
  2. Subtract from this any guaranteed income, such as social security and after-tax pension benefits or annuities.
  3. Take this difference and multiply it by 25. In this article, they assume that a 65-year old lives until 90. This age is a conservative estimate, based on information from the Social Security Administration.

What isn’t stated in the article about your retirement nest egg

While I enjoyed this article, it made some assumptions about your retirement nest egg. For instance, the suggested value doesn’t include uncertain investment returns or inflation. The net effect of including both of these would typically give a retiree more years of retirement income. The extra income would come from a conservative investment in retirement, less inflation. Using a 4% conservative after-tax average return and 3% average inflation, this net effect would provide a 1% gain (on average) each year.

We hope you enjoyed our commentary! If you would like to see more like these, please send us a message.