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I’M A BELIEVER. SURE, I stray every now and then. But after a late start, I’ve now been a devotee of exchange-traded funds for many years—though some of the ETFs I own would be considered actively managed.
In his iconic A Random Walk Down Wall Street, Burton Malkiel strongly advocates long-term passive investing as the strategy of choice for individual investors. But he also confesses to having been “smitten with the gambling urge since birth.” Acknowledging that index fund investing can be “boring,” he takes pity on folks like me with “speculative temperaments,” who may need to indulge those instincts with some small portion of their portfolio.
Thus absolved for intermittently falling off the wagon, I thought it might be of interest to readers—and useful for me—to sketch out how I’ve invested the bulk of my taxable account. (I plan to write about our household’s retirement accounts in a separate article.) I’m a big believer in diversification, perhaps the only free lunch on Wall Street.
By that, I mean I pay careful attention to my portfolio’s stock-bond allocation, mix of U.S. and foreign stocks, balance of growth and value, size of companies owned and even sector tilts. I’m a semi-retiree who needs cash to compensate for his overinvestment in illiquid real estate, while also hoping to increase my net worth for my heirs.
Toward those two ends, I’ve put together a moderate growth portfolio. It throws off a healthy 6% yield and is structured to participate in about two-thirds of the stock market’s move, whether those moves are up or down. Yes, I shortchange myself in bull markets. But a stubborn anxiety dictates that my ship be seaworthy during the inevitable storms, or there’s a danger I may bail.
So, what’s this longwinded guy own? Because each is so diversified, I’m happy to own just four main ETFs in my taxable account. One fund is almost half of my portfolio, and the other three are held in roughly equal amounts. By the lottery of birth and parents, I am constitutionally ill-suited for high-octane investing and thus deliberately underweight technology.
I consider JPMorgan Equity Premium Income ETF (symbol: JEPI) my core holding. It’s a covered call fund that combines the income from selling call options with dividends from high-quality companies, and it currently yields almost 9%. But it comes with three significant caveats.
First, it isn’t designed to generate capital gains, but it’s still sensitive to market declines. The ETF has a slight technology overweight, but the options-writing strategy gives me a relatively safe way to venture into that forbidden territory. Second, the options strategy means this “buy-write” ETF counts as actively managed, with a relatively high but bearable expense ratio of 0.35%. Third, all the income it generates means the fund is tax-inefficient—but that doesn’t bother me, because I need that income for living expenses.
Meanwhile, among my three other taxable-account funds, Vanguard International High Dividend Yield ETF (VYMI) gives me a substantial non-U.S. presence. It’s widely diversified across countries and benefits from Vanguard Group’s trademark low costs. Because foreign companies tend to pay higher dividends than U.S. firms, the ETF’s distribution rate is around 4.5%.
Okay, we’re moving on to my technology neurosis, so you can now start to guffaw. I have approximately 15% of my taxable account in iShares Global Tech ETF (IXN), which provides most of my portfolio’s growth-stock component, as well as supplemental international representation. The iShares offering has a relatively high expense ratio for an index fund and its dividend is nominal.
Until recently, Vanguard S&P Small-Cap 600 Value ETF (VIOV) was one of my positions. After holding it for many years, I gradually became disillusioned with its performance. As of November, its year-to-date return trails its Morningstar category average by four percentage points, putting it in the group’s bottom 16%. Its three-year record misses by two points a year and ranks in the bottom 28%. This is unacceptably poor performance for what’s presumably an index-hugging ETF.
I have therefore replaced Vanguard’s ETF with Avantis U.S. Small Cap Value ETF (AVUV). It’s another one of those reprehensible active ETFs, but it charges only 0.25%, unusually low for such a fund. To boot, this year it’s in the top 20% of its peers. Over the past three years, the Avantis fund’s 17% average annual return puts it in the top 6% of similar funds. Of course, a few years does not establish the durability of any outperformance, but the comparative loss in last year’s turbulent market was six percentage points less than its Vanguard counterpart.
When I was growing up, I was told only three things really matter in life: your health, your family and your friends. My parents were right as far as they went. But as a fourth item, I’d tack on Morningstar’s portfolio management tools, especially its Portfolio X-Ray 
analysis. In the accompanying chart, you can see how the holdings of my four ETFs are distributed across the Morningstar style boxes.
To be honest, I hadn’t peeked at my size and style allocation for quite a while, and I feel pleased. The large-cap allocation could not be more balanced and I have my intended overall value tilt. I appear to be underinvested in small-caps. But in my head, I combine them with mid-caps because they tend to move in tandem.
Dig deeper into the numbers and I see my desired underrepresentation in the technology sector, with me at 20% versus the S&P 500 at 28%. My average annual expense ratio is 0.31%, a little higher than optimal but for my purposes still acceptable. According to Morningstar’s Portfolio X-Ray, I have one-third international exposure. Over the past year, I’ve captured about two-thirds of the global market’s performance, which is my goal for up markets. That’s nothing to brag about, but also no reason to despair.
I take some solace in having done acceptably well, despite a light exposure to the tech sector that’s lately propelled the market’s advance. In addition, a small cash position undoubtedly detracted from my performance.
Steve Abramowitz is a psychologist in Sacramento, California. Earlier in his career, Steve was a university professor, including serving as research director for the psychiatry department at the University of California, Davis. He also ran his own investment advisory firm. Check out Steve’s earlier articles.
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Marty I have been contemplating adding a $70k position in SCHP to my IRA thus reducing my cash balance, this is an ETF that holds intermediate term bonds and they more more volatile than short term bonds. If the Fed does cut interest rates in 2024 SCHP will enjoy greater price growth due to the longer duration and I will have offset the decline of interest I have earned on my money market balance. I keep some cash on hand for dry powder as well as Roth conversions.
I also hold VTIP and VTAPX in my IRA today and see there has been an exodus of redemptions for TIPs in general. I wish I had a crystal ball to know what tomorrow holds but who knows when the sky will fall…I like to follow the habits of the other HD members and hold onto my investments and remain positive.
Good luck…
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Sorry for the late response. I agree with you that if the Fed does gradually lower rates, the intermediate bonds will appreciate. Your TIPS have already bounced.
See below
Steve – extremely interesting writeup; thank you for writing. You mentioned you need the income of the less than tax efficient JEPI. Have you thought of generating “income” through selling LT capital gains to get a more favorable tax outcome?
Yes, and I occasionally do. But sometimes I don’t want to reduce the stock portion of my portfolio. Right now, I have become disenchanted with JEPI, whose distributions (largely from option sales) drop in the kind of low-volatility environment we now have.
Steve, thanks for another interesting article! I’m always curious how others invest their money. You mentioned Morningstar – are they one of your favorite sources? They offer a plethora of good information, along with their podcasts.
Morningstar is definitely one of my favorites. I have a lot of respect for their willingness to evaluate the outcomes of their own recommendations.
Morningstar is one of my investing guiding lights. I pay $250 a year for their Premium memberships so I can access their portfolio x-ray platform which is the tool which I utilize for rebalancing that is Steve references here. Sure beats a portfolio advisor’s 1% management fee. Also Christine Benz is one of my investment advice idols as her articles are so valuable. She replaced the late John Bogle in my investing Pantheon
Totally agree. I’m also a big fan of John Rekenthaler, at least when I can follow his in-depth analyses!
I get free login access to Morningstar and ValueLine by logging into my public library system. Try it if you live in the U.S.
A good tip for everyone.
I agree. I find them comprehensive, long-term oriented and—perhaps most importantly—responsible. I also like that they cover both mutual funds and ETFs. My only real quibble is that they are too receptive to active investing.
Do your real estate investments cash flow / bring in cash?
For sure. Why invest in income property if there’s no net income? For small residential income property in much of California though, you’ll be hard-pressed to get over 5% annually after expenses. But then tack on very attractive long-term appreciation potential, depreciation allowance and other substantial tax advantages.
To each his own! I’m sticking mostly with broad market ETFs like VTI & VXUS. My portfolio’s expense ratio is about 0.05%.
Really a great way to go. I hope your family appreciates what you’re doing for them.
Steve, thanks for peek inside your portfolio, and your brain. You certainly open up the books each time pick up your pen.
Thanks for the kind words.
Absolutely a fools game to own individual stocks. Even Buffett would tell you to buy sp500 index fund
read simple wealth by nick Murray and it will be a game changer
I don’t like to say any one investment strategy is doomed to failure, but l if I had to choose one it would be as you say. Even folks who believe they are adequately diversified are often tilted toward one factor or another.
Of course one can tilt to a factor(s) and still be diversified. Your own portfolio seems to be one example. Enjoyed the article.
Sure, you’re right. And wouldn’t it have been nice to have a small slant toward small caps recently!
Steve. Good stuff. Any bond funds/ETF’s that you like with the Fed saying rate cuts next year? Or has the easy money already been made?
Check Morningstar for vast coverage of bond mutual funds and ETF’s. If interest rates do come down, we will probably see a continuation of a bond rally. But remember if that likelihood does occur, stocks—which are more volatile than bonds—might rally more strongly.
I’d like to hear some opinions on rate cuts and small cap potential in 2024.
I’d like to shy away from offering any specific advice without knowing a reader’s individual financial situation. I think the Fed suggested yesterday that rates may be reduced next year. Many “experts” believe small stocks to be undervalued but, remember, this has been the case for several years.
Owning individual stocks is not necessarily speculative. If you know how to analyze company financials, you can choose the most solid, conservative blue-chip companies, and create a portfolio that is most suitable to your personal financial circumstances.
Such a portfolio will have much lower volatility than the overall market.
Yes, you can certainly construct a “conservative” portfolio of your own, but how likely is it that it will be adequately diversified? Many respected market observers have suggested holding less than 20 individual stocks does not effectively eliminate single-stock risk. And to accomplish that would consume more time and effort than most of us can afford. Remember that most mutual funds are managed by graduates of some of our most elite business schools. Even they cannot create portfolios that can beat simple index funds. How likely is it that you or I can do better? Also, hundreds if not thousands of funds are available that invest in conservative stocks that are less volatile than the overall market. It sounds like you have been skilled and fortunate enough to effectively run your own show, but most of us would not be able to do so.
I would not put more than 3% of my financial assets in any one security – following this rule has saved me from many disasters.
I am not trying to “beat the market”. I am not sure that the market even exists, or what it might consist of. My goal is to preserve capital and get the income I need to live. So far, so good.
Sounds like you’ve found a way to get what you want and need from the market. That’s the goal we’re all striving for, each in our own way.