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VTI: A Good Low Cost U.S. Market ETF For Your Portfolio

Summary Investing can be as simple or as complex as you want to make it. Many investors should start with one well diversified global ETF with a low expense ratio. This article reviews VTI, an ETF that can be added to the core portion of most investors’ portfolios to increase exposure to U.S. market equities. With the strong recent performance of the U.S. market, investors should consider using dollar cost averaging if adding large new investments in U.S. equities to a portfolio. Simply Investing – Philosophy Keep investing simple, consistent, diversified and low cost and you will significantly increase your chance of success. One well diversified global ETF with a low expense ratio is all that is required for many people starting to invest in equities, and an ETF that meets these criteria is the Vanguard Total World Stock ETF (NYSEARCA: VT ). As an investor’s experience, time dedicated to investing activities and desired risk, increases, many investors add ETFs to the core of their portfolio to gain exposure to new areas or increase exposure to areas that the investor believes will outperform. The next step for many investors is to allocate a percentage of their portfolio to “edge” positions, which offer additional risk and opportunity. Vanguard Total Stock Market ETF (NYSEARCA: VTI ) This article reviews VTI, an ETF that can be added effectively to the core portion of most investors’ portfolios to increase exposure to U.S. market equities. VTI – Investment Synopsis VTI’s objective is to track the performance of the CRSP U.S. Total Market Index. VTI invests in large-cap, mid-cap and small-cap equity diversified across growth and value styles. VTI employs a passively managed, index-sampling strategy. VTI five year performance compared to the S&P 500 (click to enlarge) Source: Yahoo Finance (12/14/2015) As the chart above shows, VTI and the S&P 500 have tracked each other very closely over the last five years and both are up approximately 60% over that period. VTI -Equity Characteristics Source: Vanguard (as of 10/31/2015) As the table above indicates, VTI is very diversified, holding 3,797 stocks. The median market cap is very large at $52.1 billion. VTI’s current price/earnings ratio at 21.9 is high compared to historical levels and compared to foreign equities. VTI – Top 10 Holdings Source: Vanguard (as of 10/31/2015) VTI’s top ten holdings are very large, well known, companies and at 15.2% of total net assets, make up a fairly large proportion of the total holdings. VTI – Equity Sector Diversification Source: Vanguard (as of 10/31/2015) VTI’s largest stock holdings are in the financial sector, followed by technology, consumer services and health care. Expenses and dividend yield VTI’s expense ratio is 0.05%, this is well below the average expense ratio of similar funds. Given the relatively high price of the U.S. markets, it is likely that future returns, may be lower than those recently experienced. In this environment, it is important that the core of your portfolio is allocated to funds with low expense ratios like VTI. VTI’s forward looking dividend yield is 1.98% based on the last four quarters distributions. Other U.S. Market ETFs Source: Seeking Alpha (12/14/2015) Above is a list of the top 10 U.S. market ETFs, listed by assets under management (AUM). As indicated, VTI is the third largest U.S. equity fund as measured by assets under management. For those that want to do further research, additional detail on these ETFs is available on Seeking Alpha’s ETF Hub. Conclusion Your chance of long term investment success increases significantly by keeping your investing simple, consistent and well diversified. Most investors would benefit by building a core position in a well diversified global ETF with a low expense ratio like the Vanguard Total World Stock ETF. After establishing this core position, well diversified, low cost, U.S. market ETFs like VTI can increase your exposure to U.S. markets for those investors looking to do so. With the strong recent performance of the U.S. market, investors should consider using dollar cost averaging if adding large new investments to a portfolio.

High Dividend Yield ETFs Deserve Further Inspection

Summary These four dividend ETFs include 3 with extremely high dividend yields for an equity fund without REITs. SDOG comes up as my favorite after I looked through the allocation strategies each fund was using. FVD reports a net expense ratio of .65% in their fact sheet. Yahoo reports a .70% net ratio for the fund. With the exception of SDOG, the ETFs currently have very high allocations to the consumer defensive sector and the utility sector. One of the areas I frequently cover is ETFs. I’ve been a large proponent of investors holding the core of their portfolio in high quality ETFs with very low expense ratios. The same argument can be made for passive mutual funds with very low expense ratios, though there are fewer of those. In this argument I’m doing a quick comparison of several of the ETFs I have covered and explaining what I like and don’t like about each in the current environment. Ticker Name Index SDOG ALPS Sector Dividend Dogs ETF S-Network® Sector Dividend Dogs Index FDL First Trust Morningstar Dividend Leaders Index ETF Morningstar Dividend Leaders Index PEY PowerShares High Yield Equity Dividend Achievers Portfolio ETF NASDAQ US Dividend Achievers® 50 Index FVD First Trust Value Line Dividend ETF Value Line(R) Dividend Index By covering several of these ETFs in the same article I hope to provide some clarity on the relative attractiveness of the ETFs. One reason investors may struggle to reconcile positions is that investments must be compared on a relative basis and the market is constantly changing which will increase and decrease the relative attractiveness. Dividend Yields I charted the dividend yields from Yahoo Finance for each portfolio. The First Trust Value Line Dividend ETF is the weakest of the batch on dividend yields. The yield isn’t weak overall, but it is lower than I would have expected. (click to enlarge) Expense Ratios The expense ratios run from .40% to .70% according to Yahoo Finance. (click to enlarge) I thought the expense ratio for FVD seemed a little too high at .70% so I decided to pull up their Fact Sheet through MorningStar which indicates a net expense ratio of .65%. For consistency sake I’ve stuck with the values reported by Yahoo in the chart, but it appears the fund is reporting a lower net expense ratio. I also checked the ETF through Charles Schwab and saw a .65% ratio there. Sector I built a fairly nice table for comparing the sector allocations across dividend ETFs to make it substantially easier to get a quick feel for the risk factors: (click to enlarge) First Glance FDL and PEY get some immediate respect from me for their very high allocations to the consumer defensive sector. It is also notable that FLD, PEY, and FVD all use heavy allocations to utilities. While several dividend ETFs include at least some allocation to real estate, there was a 0% allocation for the first 3 ETFs. As we get into ETFs with higher expense ratios, it is worth noting that many may have more complicated weighing structures that will materially vary over time and therefore the investor needs to either buy in completely to the strategy of the fund or keep an eye on the sector allocations or both to prevent becoming overweight on specific sectors. SDOG SDOG uses the most even allocation strategy out of all the funds. I have to admit that I like that part of their strategy. I wondered if that was random chance or if the company was doing it intentionally, so I pulled up the quarterly factsheet . It turns out that this is an intentional choice and that the portfolio is designed to maintain that allocation: “SDOG provides high dividend exposure across all 10 sectors of the market by selecting the five highest yielding securities in each sector and equally weighting them. This provides diversification at both the stock and sector level.” FDL The allocations for FDL feel pretty heavy on communication services to me, but each fund here changes their positions materially over time. The process for building the index includes a “Proprietary multi-step screening process”. There are a couple other comments, but in general it seems the system is designed to create a bit of a black box. Investors that want to read further into it can check out the fact sheet . PEY PEY is based on the NASDAQ U.S. Dividend Achievers 50 Index. Both the fund and index are reconstituted each year in March and the positions are rebalanced on a quarterly basis. Again, it is possible for the sector allocations to change materially which makes it important to look into the positions regularly. I appreciate funds that opt for a strategy with more rationality behind it than “the portfolio is market-cap weighted, we don’t do anything”. On the other hand, when the fund does not appear to be using strict sector weight limits it creates some risk of having more concentration than I would want in the portfolio. The yield is great and I really like the current allocations, but there is a material risk of the portfolio changing significantly in March. On the positive side, since the index is only reconstituted once in March each year investors can take a look at which securities were selected and decide if they feel comfortable holding that portfolio. If the investor believes in rebalancing, then the expense ratio on the fund may be significantly cheaper than the commissions the trader would incur. FVD The allocation process for FVD is also fairly complex. The index is based on whittling down the available universe of stock securities based on their Value Line® Safety Rating. After the available universe has been screened, the fund picks the companies with dividend yields that are higher than average for the S&P 500. To avoid allocation to smaller companies, anything with a market cap below $1 billion is removed from consideration. What do You Think? After looking through the allocation strategy for each fund, I think SDOG is my favorite of the batch. Which dividend ETF makes the most sense for you?

2 Screens To Avoid Bad Investments

Summary There’s no way to avoid all investments that end up performing poorly, but there are two screens that can avoid some of them: past price performance and hedging cost. We applied those two screens to a list of top investor picks three months ago, and the ones that passed both screens significantly outperformed the others. We elaborate on the two screens, and discuss why they work. We conclude with a suggestion to consider applying these screens to guru picks, and to consider diversifying or hedging to limit risk. A Bad Fall For Top Investor Picks In a late August article (“Best Q2 Picks From Top Investors”), Seeking Alpha premium contributor and hedge fund manager Chris DeMuth, Jr. highlighted what he felt were the best stocks top investing gurus such as Warren Buffett, Carl Icahn, and Seth Klarman (Klarman pictured below; image from DeMuth’s article) added or increased their weightings of in the second quarter. On the whole, these picks have performed poorly over the last three months. In hindsight, this is consistent with the narrowness of the current bull market, one dominated by the “FANGs”, Facebook (NASDAQ: FB ), Amazon (NASDAQ: AMZN ), Netflix (NASDAQ: NFLX ), and Google (NASDAQ: GOOG ), as John Authers noted in a recent Financial Times column. But what’s interesting is the divergence in performance between two groups of these stocks. The first group includes the guru picks that passed two screens to be included in a Portfolio Armor hedged portfolio, and the second group includes the guru picks that didn’t. One of those screens is simple enough you can run it without any specialized tools. We’ll detail both of the screens below, but first, here’s a look at how the two groups of guru picks have performed over the last three months. Guru Picks Portfolio Armor Included, 3-Month Returns: Advance Auto Parts (NYSE: AAP ), -14.43% Precision Castparts (NYSE: PCP ), +1.19% Cigna Corporation (NYSE: CI ), – 1.75% Danaher Corp (NYSE: DHR ), +10.83% Humana (NYSE: HUM ), -8.16% Perigo (NYSE: PRGO ), -16.2% Shire (NASDAQ: SHPG ), -8.5% Time Warner (NYSE: TWC ), -2% Average 3-month return: -4.88% Guru Picks Portfolio Armor Rejected, 3-Month Returns: SunEdison (NASDAQ: SEMI ), -32.06% SunEdison (NYSE: SUNE ), -71.15% Williams (NYSE: WMB ), -40.8% Baker Hughes (NYSE: BHI ), -6.83% Office Depot (NASDAQ: ODP ), -24.33% Altera (NASDAQ: ALTR ), +5.94% Icahn Enterprises (NASDAQ: IEP ), +0.54% Brookdale (NYSE: BKD ), -29.6% T-Mobile (NASDAQ: TMUS ), -6.47% Average 3-month return: -22.75% Screening Out The Worst-Performing Picks In an article published in early September (“Investing Alongside Buffett, Klarman, And Other Top Investors While Limiting Your Risk”), we entered each of the guru stock picks above into Portfolio Armor’s hedged portfolio construction tool. That tool works differently depending on whether you enter your own securities or not. If you don’t enter your own securities, the tool populates your portfolio with the securities with the highest potential returns, net of hedging costs, in its universe (its universe consists of every stock and exchange traded product with options traded on it in the U.S.). If you do enter securities, as we did with those guru picks, the tool performs two screens on the securities you enter before attempting to calculate potential returns for them. Screen #1: Most Recent 6-month Performance V. Long Term The first screen is one you can easily do yourself. The tool looks at how the ticker performed over the most recent six months and compares that to the average six month performance of the security over the long term (ten years, if a stock has been around that long; if not, it uses the long term returns of an industry competitor as a proxy; for exchange-traded products it uses since-inception returns if it hasn’t been around for ten years). The tool will reject any security with a negative return over the last six months, unless the average six month return of the security over the long term is greater than the absolute value of the most recent six months return. To illustrate this, let’s look at one of the guru picks that failed this screen, SunEdison . Below is a chart, via Yahoo, showing the performance of SUNE over the 6 months prior to when Portfolio Armor rejected it for inclusion in that September hedged portfolio: (click to enlarge) SUNE was down 48% over the six months prior to early September. The only way it would have made it past this screen is if its average 6-month performance over the last 10 years was greater than 48%, and, as you might guess, that wasn’t the case, so SUNE failed the first screen. Screen #2: Hedging Cost Since SUNE failed the first screen, it was eliminated. An example of a stock that passed the first screen, but failed the second, was Williams . WMB was down 3.25% over the most recent six month period as of early September, but its average 6 month performance over the previous 10 years was 4.81%, so it passed the first screen. But it was too expensive to hedge against a greater-than-9% decline over the next six months using an optimal static hedge, so it was rejected. We explained how to find optimal hedges in a previous article , if you’re willing to do the work manually, or you could use an automated tool such as our hedging app . Why These Two Screens Work Although these two screens don’t eliminate all poor-performers, they work to eliminate some of the worst performers. They both employ what New Yorker columnist James Surowiecki termed the wisdom of crowds : Large groups of people are “smarter” than an elite few, no matter how brilliant — better at solving problems, fostering innovation, coming to wise decisions, even predicting the future. The large group of people in screen #1 is the stock market, and the large group of people in screen #2 is the option market; the elite few are the top investors who picked the stocks. Conclusion If you’re going to buy gurus’ stock picks, consider buying ones that pass these two screens. And since these screens don’t eliminate all poor-performers, consider limiting your stock-specific risk by diversifying or hedging.