The challenges of building a lazy portfolio

Let’s talk about W8 BEN forms. YEAH!!

Thanks James for an excellent and thought provoking article.

Interesting that the Mercer Index Growth Funds (& other managers similar) have matched or beaten the typical Default Industry Super Fund, for about half the cost. These index growth funds are professionally managed, using a range of low-cost ETFs. The other good news is that the fees on these funds are steadily coming down. Mercers Index funds are set for an investment manager fee cut soon. Alternatively, put your core holdings in an index growth/all growth portfolio and allocate some funds to satellite ETFs ( eg FUEL or IIND with Betashares) for some active managing yourself.

Yeah Vanguard is all great till you get your W-8BEN for and similar- completely incomprehensible accompanied by advice from forms@computershare.com to seek professional advice. 3 accountants later, no success.
It’s a great tax treaty.

Absolutely correct mate?????

I started using the Member Direct option in my Superfund about 16 years ago. My balance is far higher than if I'd left it in Balanced or High Growth options of my fund. Active is still the go for me.

Nice article James, really enjoyed reading it....... as well as some of the questions in the comments and the occasional "my one's better than yours" stance which give me a laugh every time.
I have a question, did you look at any of the High Yield ETF's such as INCM and VHY for the locals and WDIV for offshore? I'm looking for ongoing yield rather than massive growth in my portfolio.
Thanks. Stephen.

Hi Stephen T,

No, I didn't look at high yield for this article. Possible grounds for a follow-up article.

I did take a cursory look now at the local ETFs. A few things to note:

1. INCM has high exposure to the US at 67%. Though it has little exposure to Tech. The likes of financials and utilities have much higher weightings in the portfolio. The fees are on the higher end at 0.45%.

2. VHY has exposure principally to Aussie large caps, and heavily weighted towards financials and commodities at 73% of the portfolio. Fees are reasonable at 0.25%.

The other thing to possibly investigate is established LICs like Argo Investments (ARG) and AFIC. LICs can smooth out dividends which can help with regular income.

Your needs, tax situation, etc will play a part in choices too.

Best,
James

Thanks James, I'm already pretty heavily invested in Aussie LIC's such as AFI, ARG, SOL, GVF and some of the Wilson offerings, was looking at starting to invest in ETF's to safeguard against the risk of ongoing, long term LIC discounts to NTA, who knows where they are heading. I'd be interested in you thoughts on which of the major low cost ETF's also benefit from a good fully franked regular dividend. Stephen.

Hi Steven, regarding ETFs offering regular, fully franked dividends - as a general rule, ETFs don't offer fully franked dividends or stable dividend streams. The reason for the former is that ETFs often hold stocks that have a mix of fully franked and partly/no franked dividends. Even high yield ETFs like VHY aren't fully franked. On the second point, dividends will follow earnings with ETFs. If earnings plummet, as they did during Covid, then dividends can be cut aggressively.

If steady/growing, fully franked dividends are what you require, the LICs you mentioned can serve this purpose well. Peter Thornhill has written on this in Firstlinks, and he makes some valid points on this subject.

A very interesting article. I have also been impressed by some of the comments made in the "replies". There should be a section in "Firstlinks" where these individuals can tell us more specific details about their portfolio as I feel that many of us could learn or at least consider their investments with a view to improving our own investment portfolios.

This would be awesome!

Two things to add to the discussion:

1) Vanguard offers ready-made ETF portfolios for 0.27-0.29% in fees p.a. which achieve similar things to the 3 ETFs here.

2) VanEck also has a good equal weighted ETF for Australia (ASX: MVW)

Yes, lazy approach nowadays should be an all in one ETF, such as VDHG. No need to rebalance or do much at all. No temptation to tinker.

You probably pay a price, ie higher fees, for that convenience.

Really interesting article.

The only thing I'd query is the time series comparison of the stock indexes fair? I take your point that things change, but it's probably fair to say the US has a better claim than a colonial power to continue its hegemony of total equities.

Its considerably the largest developed country and this isn't changing any time soon. Putting aside some of the valuation issues in technology, it dominates a sector that looks like it will enjoy very healthy margins for a very long time. Its equity market has so much capital that it's a bit like the sun. If you're a UK or Australian technology company that has global potential, why go public locally when you could list over there? Same for talent. Technology just makes it easier for US companies to continue to get the best global talent.

And geopolitically there's no real alternative to a US-based order. A trade war with the US may make the US poorer... but everyone else is in the same boat.

If there's a historical comparison, the US is more Roman empire than 19th century colonial power. And like Rome I think any threat to its dominance is probably domestic.

In saying all that, +1 for diversification and risk tolerance. It's fun to speculate but who knows what the future will hold.

Like all things no one-size-fits-all answer. If one is in accumulation phase then all is good either way, but if one is in a pension/income producing phase, some allowance for cash flow should be considered. High US exposure has low dividend payment (no franking either) which means you need to sell some assets to cover nominal income streams or draw down your cash reserves. Being forced to sell when the market is low is not flash. So in this case having some or ideally all or nearly of the income stream covered by dividends/interest etc is very helpful as it leaves the growth assets largely untouched. A modest cash buffer can cover the difference. For example if one plans to spend 5% of assets, getting say 4-4.5% overall income means you only need to bridge say 0.5-1% from cash reserves without being forced to sell down growth assets. This may influence the split of international/domestic shares as well as cash/fixed interest. Higher interest rates certainly have helped this issue. But I do agree a fairly simple mix of ETF's can largely cover this (Morningstar have model ETF portfolios based on risk profile for example). Interestingly Morningstar have around 8-10 ETFs per portfolio rather than just 3 or so; allows a little more flexibility without straying too far from the simplicity objective.
One last bit I find under-represented is floating rate bonds (eg ETF's like FLOT, QPON, SUBD, HBRD) largely mitigates the capital risk of pure fixed coupon bonds which have taken a hammering of late.

Something to be aware of is that some ETFs, like VEU and VTS, are dominciled in the US rather than Australia. Australian investors who buy ETFs domiciled in the United States incur a 30% withholding tax on distributions. A US domiciled ETF brings the complication of having to deal with the US tax system and completing an IRS W8-BEN form. So I avoid US domiciled ETFs.

NAB Trade completes the w8 ben for me automatically to reclaim a 15% foreign tax credit

You also need to be mindful of US estate tax complications that come into play when a "non-resident alien" (that's most Aussies to the US IRS) owns "US-situs" assets. Don't dare die until you've sold them - otherwise your estate could be in for a world of hurt.

Hi James - great article. You've covered a lot of the questions people face when trying to put together their own portfolio. Your comment on the 60/40 portfolio and calls of its demise tickled my interest. It would be great to see what a simple 60/40 portfolio would achieve against your final outcome. Nothing too hard - just a standard global capitalisation ETF for the 60% and diversified bond fund for the 40%. And let currency do whatever it might do. I'm not saying this is a great portfolio, but it would be fascinating to see how this compares over time to yours, if it were used as a reference benchmark..

went thru v. similar exercise a few yrs ago. Assumes gradual loss of capacity or heirs that are less competent.

Issues & considerations as you state above

my 2 bits worth :some additional considerations presumably you have taken into account :
1. Currency & country risk. You & your heirs need decide where you want to live. If is is Oz then you will need more VAS exposure either
a. arbitrary allocation of 25- 30% to VAS (see VDHG's allocation as a rough guide)
b. build dividend/interest AUD cash flow to ensure it meets the ASFA comfortable retirement standard cashflow.

2. The rest can be overseas allocation.
Here is where your worries about overweighting in US and Tech comes in. If you are talking completely passive then you allocate according to market cap. size using VTS and VEU both (are extremely low cost.)
If you want to be part active then play around as James Gruber has, otherwise allocate according to Market cap

Fine tuning if you want to up to 5-10% of total portfolio eg. Emerging markets, small caps, health care ETFs

3. If you have a massive portfolio then you can minimise/avoid bonds/cash altogether. How much you hold will depend on your risk appetite and your portfolio size vs your living expenses.
Check if your anticipated dividend flow is sufficient to live on if it drops by 20-30%.
Otherwise have a Cash bucket for about 1/2 the length of a business cycle i.e. about 4 yrs. if you(or your wife) cannot sleep at night without one.


4. Considerations for bonds/cash:
Cash - no duration risk. Inflation and tax will nibble at it.
Bonds - Long duration or medium - capital risk. Govt vs. Corporate ( higher quality BBB and above ). Depends on your risk tolerance.
Currency : take your pick ! May not matter much. AUD as with J. Gruber's a good idea since there is minimal Aus share market exposure in the portfolio.

At B2, just had a look and the annual expenditure needed to reach ASFA's comfortable retirement standard rose another 1.1 percent in the March quarter to hit a record high of $70,482 per year for couples, and $50,004 for singles

I already did.
Hence the reason why you need sufficient AUD asset exposure if you or your heirs want to live in Australia.
If you are going to spend a lot of time in Europe then you should increase European exposure to avoid being priced out of living in Europe.

A very interesting read, thank you. Have you considered the argument that longer term, expenses are in Australia so some higher exposure to Australia is appropriate?

Hi John, for some it will be. Depends on personal circumstances.

I think one of the premises of the Bogle philosophy is that the more "active" (ie. making a decision) one gets in their portfolio construction, the chances of making a poorer-returning decision relative to the market return increases.

After all the considerations you were thinking about making, the close you got to being "active" in your construction. In the end, choosing only 3 ETF's meant you kept closer to the passive end of the spectrum (which was your objective at the outset).

I like many others are very interested in your approach to building a Lazy Investment Portfolio.
Why I have not followed your example over the last couple of years and consider your current move is premature.

1) It is currently a stock pickers Market -- not a good time to chase an Index via ETF's
2) Insto's are deleveraging from asset classes and going to Cash many at 40% now anticipating Recession and
better pickings
3) Interest Rates are at record Highs for the last 10-15 years, therefore, calculating values by current DCF discount
rates produces a poor result and is questionable??
$) The world Indexes are at or near record Highs- so you have bought at the peak of the market?? Is this wise? Even
if you are intending to hold for 10 years . I don't think so.- Why not wait for the forecast Recession then jump?
6) US Stocks are very Overpriced. Particularly the IT Sector and famous 7 making up approaching 50% of the index.
7) US Banks are terribly overexposed to Bonds /Treasuries with many regionals technically insolvent due to the
carry cost and could precipitate another crash.
8) Banking NIMs worldwide and are under pressure here in Australia as well due to increasing competition from
new Internet startups.
9)The Wars in Ukraine and now Israel may expand globally with China continuing to threaten the invasion of
Taiwan creating the worst global situation in my lifetime of 76 years. Very unstable investment horizon.
10)You have bought a passive concentration in ETF's which I agree provides a Balanced exposure to Stocks
and Bonds, however, you are now exposed to a long-overdue Global Recession.

A last word on Recession likelihood. The last 9 out of 10 Recessions have been preceded by an Inverted Yield
Curve. This is still inverted, although narrowing!!

I hope your big guess works out for you
I am in OZ major Bank Hybrids paying 6-9% with a few dog Stocks I am trying to lose.
Lower risk than your ETF's and far better Dividends.

The true word of someone who still believes in active management. Passive has dominated for the past 40 years, and shown to hold up during so called “it’s a stock pickers market”. 

The enitre point of this article is to avoid the overthinking your 10 comments make. Trying to time markets and make stock or sector selection decisions is fraught and the three-ETF approach is intended to remove the inherent behavioural and cognitive biases to which any overthinker will be prone.

"My problem with this is that the US market looks expensive compared to the rest of the world. And I’m not sure that the US will command such a large share of world equities in the long term".

BGBL will take care of this over time by re-weighting its exposure to the US as (if) other countries start commanding larger shares of world equities. With a 50/50 split, you are making an active decision rather than letting the market decide.

Tim,

This is true, and it's why I wrestled a lot with the issue.

What if your portflio is say $5m. Would you follow the rule 3 ETF's
Nath

Nath,

I can't give personal financial advice. As a general rule, the theory of a lazy portfolio is designed to meet anyone's needs.

Bond funds can and do deliver negative returns as the past few years have shown. Cash and term deposits do not.

They do produce negative returns, quite often, on a real returns basis (ie. post-inflation). Time series data shows that bonds perform better than cash / TDs on a real returns basis.

Did you take a look at your portfolio - by sector too. The big 7 and many other are global companies and arguably earnings are from outside US and Australian equities very concentrated as you note

Hi Jeff,

I did look by sector too. My issue with a global ETF is you're not only getting a lot of US exposure. Within that, there's also a lot of tech exposure. It's not only the valuations of US tech that worry me. It's also that the weighting of the tech sector in the S&P 500 at close to 28% is deceptive. Because that weighting excludes companies like Amazon, Netflix, Tesla, Alphabet, Meta, Visa, and Mastercard, which are classified as non tech though they probably shouldn't be. Add these stocks in, and the 'real' tech weighting in the S&P 500 increases to 41.5%. That compares to 35% at the peak of 2000.

So, with a global ETF, you're getting concentrated US exposure and concentrated tech exposure. Some may like that. I don't.

Did you consider US/AU dollar valuation?
I have held off buying US share ETF due to current exchange rates.

Hi Michael,

I did and probably should have mentioned it. I'm ok with the currency risk as this is a long-term portfolio (+10yrs) and I'll likely to be adding to the portfolio over time, which should help to smooth out currency movements.

Really good read thank you My simple set and forget is VAS / IVV / VEU for equities outside of the SMSF and I added VAP and IAF inside it for property and bonds. It is extremely tempting right now to add complexity and try and tweak things around, but I just keep zooming out at the very long term and I keep adding to my current positions. I’ve recently been investigating various ways to gain exposure to more Asia and India markets, but the costs outweigh the potential gains. We will see!