I recently rolled over an IRA worth around $170,000 from a previous employer into my personal investment account. This provided me with the opportunity to construct a portfolio based on my risk tolerance as well as a pretty cool after-hours activity. I follow a variation of the Boglehead’s portfolio philosophy of investing in broad or total market index funds, but with a small/micro tilt with US REITs. In aggregate, the $170,000 is distributed across 6 funds. The core (over 80%) of the portfolio remains in a market-cap weighted group of index funds as outlined below. Technically the small-cap ETF value fund is classified as ‘enhanced’ strategy (this weird middle ground between index funds and actively managed) in that the fund attempts to track a sub-segment of the overall market. Personally, I think we’re arguing semantics, and if its there is any ‘active’ management taking place, then just classify it as active.
If you have a Fidelity account, you can use its equity stylemap to determine the fund’s investment style. Using OPGIX as an example, we can see that the fund is classified as a mid-cap growth because it’s focused on firms with a valuation between $2 billion and $10 billion. Note that this fund will also invest up to 25% of its holding in what most people call ‘junk-bonds’, this is not technically called out in the equity style map so it’s important that you read the prospectus before you invest in any fund. The composition of your portfolio should reflect your risk tolerance over a long time horizon, not just today.
My rationale for selecting OPGIX is aligned to my investment thesis of providing a “tilt” towards small-value and mid-growth funds which, on average, outperform the market. An interesting analysis I like to perform is a back-test against an index fund like SPY. Adjusted for inflation, a hypothetical $10,000 growth chart from 1993 to 2019 indicates a portfolio valuation of $156,681 vs $95,129. It’s worth pointing out that this fund was more volatile over the same time frame, with lower lows but also higher highs. Also keep in mind actively managed funds carry an expense ratio which is always higher than an ETF or mutual fund which tracks an index. In this case the E/R for OPGIX is 1.13%, while SPY carries an expense ratio of 0.09%.
So, satisfied with the expense ratio, risk tolerance, and exposure as determined by reviewing the equity stylemap and prospectus of each individual potential funds, we can see that my portfolio has approximately 70% of its funds allocated to large-cap investments.
What’s interesting is when I tried to create a target asset allocation chart to track and visualize what percentage of my portfolio is US Stock, World, REIT and US Bonds, I used the fund’s geography objective as my guiding light. With SYLV as an example, you can see the geography objective is US, so this fund would be classified in my portfolio as ‘US Equity’.
Similarly, for Fidelity’s new Total Market International Index Fund (FZILX), examining the fund’s Country diversification, we can see that it has international holdings, inclusive of the United States, so this is classified as “World”. Note there is a slight difference in how this analysis took place (atleast through Fidelity’s portal) because SLYV is an ETF while FZILX is a mutual fund, but the end result is the same.
Following this framework, we’re able to conclude that the asset-allocation of this portfolio is approximately 60% US Stock, 25% world, and 15% Bond/Bond alternatives, as outlined below.
What I found interesting in this analysis of asset allocation across the individual funds, is that funds would be classified as ‘US Equity’ or ‘Geography = US’ despite having international holdings. Taking Fidelity’s ‘US Bond Index’ (FXNAX) as an example, we assume its holdings are supposed to be in US Bonds such as the United States Treasury, right? The index it tracks is the Bloomberg Barclays U.S. Aggregate Bond Index. Although this is true, the fund actually has international bonds, despite being called a ‘US Bond Index’.
When we actually take a moment to read the prospectus, we’re reminded that the fund actually has international holdings, for example: Chilean Republic, European Investment Bank and Petroleos Mexicanos. Although it’s not the end of the world, it’s important to understand what you’re really investing in and why a fund which tracks a US Bond Index has international holdings. Reading the prospectus we can conclude that the fund invests at a minimum 80% of its holdings in bonds included in the Bloomberg Barclays U.S. Aggregate Bond Index and international funds which are traded on domestic markets.
FXNAX isn’t the only fund which tracks this index, so it's a worthwhile activity to perform a hypothetical investment back test on VBTLX, which tracks the same index. The result? Identical.
It’s worth noting that individuals should calculate the weighted expense ratio of their portfolio to ensure fees are aligned with their expectations. You can see below the calculation for determining your expense ratio is pretty straight forward. In this portfolio, the E/R is .001 which is one-thousandth of one percent. This means that for every 1000 dollars invested, around 1 dollar will go towards the expense ratio. Since there are 171 ‘thousands’ in $171,000 my expense ratio will be 0.001 x 1000 x 17, which (including rounding) is approximately $226 or (226/171000) =~ .001.
1. Determine the funds individual E/R.
2. Calculate the E/R cost by multiplying the E/R x initial price.
3. Sum the total E/R cost.
4. Divide the total E/R cost by the total initial investment.
Does any of this matter?
For us data geeks, this is a fun intellectual activity that we like to do in our leisure. But ultimately there is only one question that matters, will this beat the market? I’ll preface this answer by saying, if I really knew the answer..like..really knew it, I would be a fund manager at Goldman Sachs. But alas, in the absence of being a psychic, the best we can do is a back-tested $10,000 hypothetical investment. After all, if this can’t ‘beat’ the market, why not just invest in the market via market-cap weighted broad or total market index funds? We’ll perform a hypothetical $10,000 growth back-test from 2000 to 2019 against the 3 options below.
Note: that in the ‘Educated but Broke’ portfolio I swapped out FZROX for VTSAX, FZILX for VTSX and FXNAX for VBMFX. These are vanguard’s equivalent of the Fidelity funds. FZROX and FZILX were just launched in 2018 so there isn’t enough data available to perform an adequate backtest. I consider these Vanguard funds equivalent to Fidelity’s since both attempt to track the ‘total investable market’ domestically and internationally. With that disclaimer out of the way, how did we do?
Did I beat the market, or am I just another lame duck? It looks like I still have a chance at Goldman. The Educated but Broke (P1) portfolio outperformed the index fund and 3-fund boglehead fund by around 1% or around $6,000 as denoted below. Bottles and models for everyone!
Conclusion? Try before you buy. Read the prospectus, understand what you’re investing in and clearly articulate your tolerance to risk. To the fellow financial independence followers, the ones who moonlight as investment bankers and the aspiring hedge fund analysts, what do you think? How would you invest $200,000 in the stock market?