Tag Archives: voo

How To Predict Fund Performance (Podcast)

By Ronald Delegge The phrase “past performance is not an indicator of future performance” is a frequently written and spoken legal disclaimer for virtually all investments sold by Wall Street. Yet, hardly anyone from individual investors all the way to investment sales people really act like they believe it. Asset flows inevitably gravitate into funds with the hottest historical performance. And if a fund happens to be christened with a 4 or 5-star rating, the money really pours in. In fact, the very first thing that retail investors and professionals infatuate themselves with is historical performance. The herd mentality with picking mutual funds goes something like this: “The _____________ (fill in the blank) fund has easily outperformed the S&P 500 (NYSEARCA: VOO ) over the past ____________ (fill in the blank) years. It’s a proven winner!” And that’s generally how buy decisions are made. Never mind how the fund’s benchmark is irrelevant or how much risk the fund actually takes or how much the fund charges. None of these petty details matter to the historical performance enamored investor. Yet, people who focus exclusively on past performance are doomed to future underperformance. It’s one of those predictable ironies, that’s confirmed in new research from Morningstar. The study highlights the mistake of emphasizing historical performance. “While we think it makes sense to consider a variety of factors when choosing funds, our research continues to find that fund fees are a strong and dependable predictor of future success,” said Russel Kinnel, chair of Morningstar’s North America ratings committee. In other words, historical performance isn’t a determining factor in future returns. Kinnel added, “We found that the cheapest funds were at least two to three times more likely to succeed than the priciest funds. Strikingly, our finding held across virtually every asset class and time period we examined, which clearly indicates that investors should keep cost in mind no matter what type of fund they are considering.” (You can listen to Ron DeLegge’s full podcast interview with Russel Kinnel on the Index Investing Show. ) Highlights of the Morningstar study include: The lowest-cost U.S. stock funds succeeded three times as often as the highest-cost funds. The least-expensive quintile had a total return success rate of 62%, compared with 48% for the second-cheapest quintile, 39% for the middle quintile, 30% for the second-priciest quintile, and 20% for the most-expensive quintile. International-equity funds had a 51% success ratio for the least-expensive quintile compared with 21% for the most-expensive quintile. Among taxable-bond funds (NYSEARCA: BND ), the least-expensive quintile delivered a 59% success rate versus 17% for the most-expensive quintile. Municipal bond funds (NYSEARCA: MUB ) showed a similar pattern, with a 56% success rate for the least-expensive quintile and 16% for the most-expensive quintile. Disclosure: No positions Link to the original post on ETFguide.com

How Would Your Portfolio Do In A 50% Market Decline?

By Ron DeLegge Prudent investing in a reckless world has become a long-forgotten idea. And the 6-year run-up in U.S. stock prices (NYSEARCA: VOO ) has certainly been a contributing factor. After love, risk might be the most misunderstood and misinterpreted word in the English language. Today, people’s perverted sense of risk management is making sure they don’t miss the next big run in Netflix (NASDAQ: NFLX ) or Tesla (NASDAQ: TSLA ). Forgetting History People have let their guard down and are once again repeating the same mistakes investors in previous eras have made by underestimating the risk character of their investments. The only difference between now and previous bear markets like 2000-02 and 2007-09 is that everybody today is older and not necessarily wiser. As a result, I felt a certain obligation to help the investing public to have a multi-dimensional and complete view of their entire investment portfolio. But figuring out how to do it on just a single written page that anyone could understand took me years to develop. When I first introduced the idea of assigning a written grade to investors’ portfolios back in 2010, I had my doubts. Would people embrace my Portfolio Report Card concept? Would people send me their portfolio data for diagnosis? How would I fit their final grade onto just one page? Would my grading system be robust enough to work on all portfolios, regardless of the size and tax status? Would people be motivated to eliminate the weaknesses inside their portfolios identified by the Portfolio Report Card? A Crucial Grading Factor In case you didn’t know, risk is one of the most important grading categories of Ron DeLegge’s Portfolio Report Card grading system. And over the past year, I’ve diagnosed more portfolios than the typical investment advisor sees during their entire career. One of the most consistent patterns I’ve seen from the Portfolio Report Cards I’ve recently executed is that people are jacked up on risk because of overallocation to stocks (NASDAQ: QQQ ). Back on Aug. 18, 2004, Bridgewater Associates (run by billionaire Ray Dalio) made a similar observation and classified it as the “biggest investment mistake.” Bridgewater pointed out that over 80% of a typical investor’s risk is in stocks and that because of that overexposure, owning other asset classes like municipal bonds (NYSEARCA: MUB ), Treasuries (NYSEARCA: TLT ), and REITs (NYSEARCA: VNQ ) does little to balance out the portfolio’s risk profile. According to Bridgewater’s analysis, the overallocation to equities at the expense of other asset classes penalizes investors by roughly 3% in expected value, which could be used to cut risk. Put another way, Bridgewater’s original assessment of investors’ portfolios back in 2004 was true and it’s still true today. A Lazy Approach The fairyland idea that prudent risk management is simply a function of doing nothing during a dreadful bear market is popular but ignorant view. First, it incorrectly assumes that bear markets (NYSEARCA: SPXS ) will be short-lived. Second, it incorrectly assumes that bear markets will only happen during non-emergency moments or when we least need our money. More importantly, the do-nothing approach of “staying the course” badly misses in the biggest way because it erroneously assumes that Joe and Jane Investor have well-designed investment portfolios. My data shows quite the opposite; that Joe and Jane Investor have poorly constructed portfolios that are one-dimensional, under-diversified, and not the least bit equipped to deal with a severe market decline of 20% or more. Figure 3, which will be in my upcoming book, provides a sober look at the math of market losses. As you can see, if your portfolio suffers a 50% cut, you’ll need a 100% return just to get back to even. And since the velocity of bear markets happen faster compared to bull markets which tend to happen over a period of years, it often takes many years for an investor to recoup their losses – that’s if they ever recover at all. And that’s exactly why having a margin of safety within your portfolio is imperative. I am grateful to the many people – individual investors just like you – who have allowed me to analyze and grade their investment portfolios. I also want you to know that my Portfolio Report Card grading system just quietly passed a new milestone: over $100 million of investments have now been analyzed and graded. How would your portfolio do during a 50% market decline? Remember: Bear markets have happened in the past and will happen again in the future. And the time to find out if your investment portfolio is architecturally sound and read for the fire is before not after the market event. Original post Disclosure: No positions

Money Managers Hate Me For This One Weird Trick…

Summary An S&P 500 ETF should be the cornerstone of a well-diversified long term portfolio. I will compare the most widely known S&P 500 ETF SPY against two viable alternatives IVV and VOO. The metrics I will use are as follows: expense, historical performance, portfolio composition, total assets, volume, yield, NAV, standard deviation, and correlation. … Which is recommending that you buy the index and call it day. Boring? Perhaps. Sexy? Nope. You know what is nice though? Not having to work until you die because you were unable to save enough money for retirement. Having money to send your children to college. What else? Not getting ripped off by some “savvy money manager” that charges predatory fees. Sure you can Seek Alpha all your life, but who do you listen to? Why pay exorbitant fees for hit or miss advice? There is an optimal investment opportunity out there, and best of all, you only need access to a brokerage account to buy into it. It is called a low-cost S&P 500 ETF. Premise I firmly believe an index fund like the S&P 500 ETF (NYSEARCA: SPY ) should be a core part of a balanced long-term portfolio. The S&P 500 is comprised of 500 of the healthiest, strongest, and most widely traded stocks on the market. Investing in an S&P 500 ETF gives the investor diversified exposure to this valuable class of equities while mitigating single stock risk. I mentioned in another article that the S&P 500’s historical long term annual returns (assuming a 20-year time frame) have ranged from 5.5% to 18% . S&P averages roughly 10% returns year over year. Holding a long term-position in an ETF like SPY is intuitively the best investing decision you could ever make (I will likely write several additional articles on this subject). However, in this particular article I will focus solely on cross-analyzing and comparing the 3 primary S&P 500 ETFs available. I personally hold a long position in SPY, but I think it’s valuable to consider two alternatives iShares Core S&P 500 ETF (NYSEARCA: IVV ) and Vanguard S&P 500 ETF (NYSEARCA: VOO ). Correlation The first thing I look for in an ETF is a strong correlation to its underlying index. SPY, IVV, and VOO all display a direct and positive correlation to the S&P 500, so thankfully tracking error is not going to be a major issue. Historical Performance & My Biggest Concern Comparable returns have always grouped closely together. Interestingly, each ETF has tended to marginally outperform the S&P 500 index in the short and long run. In the last five years the index and each ETF saw around 14.75% returns annually. However, I believe this percentage is uncharacteristically high due to persistently and artificially low interest rates. This phenomenon is mostly guided by Fed backed programs which I believe have produced inflationary upward pressure on stock prices. My biggest concern for this ETF is that the stock market as a whole appears overvalued, and a market correction does not seem unfeasible (at least in the short term). As a long term investor, I am maintaining my position, but do not be surprised if these ETFs do not have future returns on par with the last five years. Comparing Key Metrics As I mentioned, I own SPY . However, I love this class of ETF, so I will not be offended if you choose to buy VOO or IVV instead. I do unequivocally recommend a long position in at least one of these. Key Metrics SPY IVV VOO NAV 208.46 209.72 191.13 Total Assets 175.95 Bil 69.8 Bil 34.33 Bil Average Volume 115.9 Mil 4.1 Mil 1.6 Mil 12-Mo. Yield 1.92% 1.99% 1.96% Expense Ratio 0.09% 0.07% 0.05% Standard Deviation 8.55% 8.56% 8.56% At first glance, SPY is the most expensive choice and offers the lowest 12-Month yield. Additionally, if you reexamine the charts I included above, you will see that VOO outperforms both IVV and SPY in the long term. However, I believe SPY derives additional value from its high liquidity. This liquidity attracts institutional investors which in turn works to lower expense. After extensive research I found that SPY is more cumbersome than IVV and VOO. Each ETF is valuable in its own way which I will soon discuss. Portfolio Composition I wanted to compare each fund’s portfolio composition by sector weighting. I found that VOO, then IVV, and finally SPY (ranked best to worst) held different sector weightings. I created an excel sheet using Morningstar data to compare and contrast each. SPY SPY Portfolio Weightings Sector Weightings % Stocks Benchmark Category Avg. Basic Materials 2.76 2.99 3.26 Consumer Cyclical 11.16 12.04 11.88 Financial Services 15.63 15.21 16.26 Real Estate 2.18 3.26 2 Sensitive Communication Services 3.94 3.73 3.62 Energy 6.91 6.82 7.62 Industrials 10.73 11.31 11.57 Technology 17.9 17.36 17.05 Defensive Consumer Defensive 9.67 8.77 8.87 Healthcare 16.26 15.63 15.59 Utilities 2.87 2.87 2.29 Critics of SPY claim it is clunky and inefficiently weighted. That claim seems overly bombastic, but there is some truth to it. SPY is underweight in: Basic Materials Consumer Cyclical Real Estate Industrials Overweight in: Financial Services Communication Services Energy Technology Consumer Defensive Healthcare Equally Weighted: IVV IVV Portfolio Weightings Sector Weightings % Stocks Benchmark Category Avg. Basic Materials 2.76 2.99 3.26 Consumer Cyclical 11.16 12.04 11.88 Financial Services 15.63 15.21 16.26 Real Estate 2.19 3.26 2 Sensitive Communication Services 3.94 3.73 3.62 Energy 6.92 6.82 7.62 Industrials 10.72 11.31 11.57 Technology 17.9 17.36 17.05 Defensive Consumer Defensive 9.66 8.77 8.87 Healthcare 16.26 15.63 15.59 Utilities 2.88 2.87 2.29 IVV has portfolio allocations identical to SPY. In regards to its benchmark (S&P 500), IVV is: Underweight in: Basic Materials Consumer Cyclical Real Estate Industrials Overweight in: Financial Services Communication Services Energy Technology Consumer Defensive Healthcare Equally Weighted: VOO VOO Portfolio Weightings Sector Weightings % Stocks Benchmark Category Avg. Basic Materials 2.98 2.99 3.26 Consumer Cyclical 11 12.04 11.88 Financial Services 15.15 15.21 16.26 Real Estate 2.11 3.26 2 Sensitive Communication Services 4.02 3.73 3.62 Energy 7.85 6.82 7.62 Industrials 10.91 11.31 11.57 Technology 17.84 17.36 17.05 Defensive Consumer Defensive 9.34 8.77 8.87 Healthcare 15.97 15.63 15.59 Utilities 2.83 2.87 2.2 VOO, in my opinion, has a better allocated portfolio and more attractive weightings. Underweight in: Consumer Cyclical Real Estate Industrials Overweight in: Communication Services Energy Technology Consumer Defensive Healthcare Equally Weighted: Basic Materials Utilities (mostly) Financial Services Investment Strategy Recommendations Whichever ETF you choose, my overall recommendation will remain the same. For this reason I will mention my overall strategy before jumping into an analysis of each ETF. Buy and hold a long position and establish a DRIP ( Dividend Reinvestment Plan ). Try to make monthly contributions to increase the compounding effect over time. Do not worry or hyper focus on short term price fluctuations. It’s difficult (if not impossible) to predict what the market is going to do. In the long term, however, you should expect attractive positive returns. Additionally, you will be able to sleep better knowing you were able to mitigate single stock risk by owning a diversified ETF. SPY SPY is structurally inefficient (compared to its alternatives), but it is cheap, well-covered, and highly liquid. You really can’t go wrong with a long buy and hold position in SPY. I would recommend SPY for beginners and institutional investors. IVV IVV is cheaper than SPY and offers the highest dividend yields (marginally). IVV is also more liquid than VOO. I would recommend IVV for high net worth individuals. VOO VOO is the cheapest and most efficiently weighted option. This Vanguard ETF historically has performed the highest of the three. While, VOO is less liquid than IVV and SPY, it is still adequately liquid. VOO does a better job of tracking the underlying index. VOO is arguably the best choice of the three. I would recommend VOO for those with some investing knowledge looking to graduate from SPY. Why Bother with an S&P 500 ETF? I could talk endlessly on this subject. I’ve already written a little bit about it, but the short answer boils down to this. Seeking alpha is a difficult, risky, and sometimes perilous journey fraught with misunderstanding, bad advice, and cognitive bias . There are a few intelligent individuals out there (and on this site) that have been able to beat the market. For the most part, however, most investors do not beat the S&P 500 . So why not just buy into it? Money managers generally do not beat the S&P 500, and they will charge you a management fee that significantly bites into your returns over time. To illustrate this, let me include one of my favorite graphs. It is easy to fall into the arms of professional money managers because we are intimidated by their financial expertise and “insider knowledge.” Often they will rationalize their exorbitant and predatory fees with backwards logic. Just invest in the index. I promise you’ll be better off. Conclusion Buy and hold a long term position in either SPY, IVV, or VOO. It could be the best investment decision you will ever make. If you don’t want to fruitlessly waste time trying to beat the market; if you don’t want to fall prey to faulty investment advice or get gouged by fees; if you want to manage risk and make money with minimal financial knowledge – invest in the index. I’m really not leading you astray here. I’m not the first person to make this recommendation and I hope I’m not the last. Don’t believe me? Listen to what Warren Buffett has to say. In regards to instructions Buffett laid out in his will, “My advice to the trustee could not be more simple: Put 10% of cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund” Side note: He recommended Vanguard Afterwards : Follow me down the rabbit hole as I cover a variety of Index ETFs (Vanguard or otherwise) to perfect your portfolio. In spite of Buffett’s advice, there is a whole world of high performing, highly diversified, low cost ETFs that deserve some attention. Disclosure: I am/we are long SPY. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.