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My Four Favorites

Steve Abramowitz

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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