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LET’S START WITH a contention that’ll get nods of agreement from the vast majority of HumbleDollar readers: Your portfolio’s core holdings should be total market index funds.
But which funds?
Frankly, the differences among the most popular total market index funds are modest and perhaps not worth worrying about. Still, worry we do. As I see it, which ones you choose depend on what you’re most focused on. Here are four key considerations:
Low cost. If your goal is the lowest-possible fund expenses, the place to head is Fidelity Investments, which offers a total U.S. stock market fund (symbol: FZROX) and a total international stock fund (FZILX) with zero expenses. If you’re looking to build the classic three-fund portfolio, you’d probably want to add Fidelity U.S. Bond Index Fund (FXNAX), which charges a tiny 0.025% in annual expenses, equal to 2½ cents a year for every $100 invested.
But while the resulting portfolio’s overall fund expenses would be tiny, there’s a price to be paid. You’d hold these mutual funds at Fidelity, and that means you’d likely use a Fidelity money market fund for your cash holdings. Indeed, these cash accounts have become the big profit center that allows brokerage firms to offer not just loss-leader index funds with minimal expenses, but also commission-free stock trades.
In the case of Fidelity, its Government Money Market Fund (SPAXX) charges expenses of 0.42%, versus 0.11% for Vanguard Group’s default money market fund, Vanguard Federal Money Market Fund (VMFXX). Typically hold a lot of cash in your brokerage account? Fidelity’s zero-cost index funds could prove mighty expensive.
Simplicity. While I’d like to pay the lowest possible cost, my preference these days is simplicity, which includes holding the fewest funds possible. That’s why my biggest stock-fund holding is Vanguard Total World Stock Index Fund.
The fund is available as both a mutual fund (VTWAX) and an exchange-traded index fund (VT). I own both, using the exchange-traded fund (ETF) for money I plan to bequeath and the mutual fund for holdings I may sell in the years ahead. Unlike the ETF, the mutual fund can be bought and sold without incurring trading costs.
As I see it, Vanguard Total World Stock is the ultimate in stock market diversification, a fund that I should never have reason to sell except to raise cash or rebalance my portfolio. As an alternative, you might consider SPDR Portfolio MSCI Global Stock Market ETF (SPGM), which has similar expenses.
While I’m a fan of total market index funds, I don’t own a total bond market index fund. I prefer to take less risk with my bonds and compensate with a larger allocation to stocks. What do I do for bonds? I aim to split my bond-market money between a conventional short-term government fund (VSGDX) and a short-term inflation-indexed Treasury fund (VTAPX).
Tax efficiency. I own Vanguard Total World Stock in various retirement accounts. But the fund has a drawback for taxable-account investors: Shareholders aren’t currently eligible for the foreign-tax credit because the fund has less than half its assets in foreign stocks.
Are you investing through a taxable account? As you build your portfolio, you’ll not only want to own separate total U.S. and total international stock funds, so you can collect the foreign tax credit, but also you’ll want to favor ETFs over index mutual funds.
Because of the way they operate, ETFs should be able to minimize capital-gains distributions and likely avoid them entirely. By contrast, stock-index mutual funds are a little more likely to distribute capital gains. An exception: Vanguard’s index-mutual funds have had an advantage for the past two decades, thanks to a special tax technique. That technique is now off patent and available for other fund companies to use.
Another important step for all investors, and not just those who are especially focused on taxes: You’ll want to keep your total bond market fund—or any taxable-bond fund you own, for that matter—in a retirement account, so you don’t have to pay tax each year on the fund’s income distributions. What if you have a sudden need for cash and all your bonds are in a retirement account, so you’re facing a possible 10% tax penalty on early withdrawals? Check out the strategy described here.
Flexibility. In addition to superior tax efficiency, ETFs offer investors added flexibility—in three ways. First, you can buy and sell them throughout the trading day, rather than waiting for the 4 p.m. market close, as happens with regular mutual funds. I see this more as a temptation to trade than an advantage, but I know others see things differently.
Second, you can purchase ETFs through any brokerage account, which isn’t always the case with mutual funds, where the cheapest—and sometimes the only—way to purchase them is directly from the fund company involved. In other words, you can own ETFs at the brokerage firm of your choosing, and you can move your holdings from one brokerage firm to another.
Finally, with so many different varieties of ETF on offer, it’s possible to take a classic three index-fund portfolio and customize it by, say, overweighting particular market sectors or investment styles. Yes, you can also do this with conventional index-mutual funds, but the choice is more limited.
So, what’s your main motivation—cost, simplicity, taxes or flexibility? Fortunately, even if you’re laser-focused on one of these attributes, it’s often easy enough to garner the other three benefits. Indeed, if you stick with total market index funds from one of the major low-cost index fund providers—meaning Charles Schwab, Fidelity, iShares, SPDRs and Vanguard—it’s hard to go too far wrong.
Jonathan Clements is the founder and editor of HumbleDollar. Follow him on X @ClementsMoney, on Facebook and on Threads, and check out his earlier articles.
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Simple, very cheap, and diversified indexes are great for most…but I have been practicing my system since 2000. My first investing book was Random walk, I started with 2 indexes in 1995, but 2000 opened my eyes.
I based my system loosely on 3 Buffet’s rules but adapted it to funds: Rule No. 1: Never Lose Money. Rule No. 2: Never Forget Rule No. 1 and Rule 3: Diversification is a protection against ignorance. I added a fourth rule: momentum. I also liked Bogles’ idea of owning just 2-3 funds but changed it to 5 funds. My system was born in early 2000. I didn’t want to own stocks so I used funds.
My generic system looks for the best 5 wide-range managed funds with good risk-adjusted performance, keeps changing them using momentum, and each fund must perform well (top 30%). You do that 2-3 times annually. The idea is to be mostly in the right category + achieve better risk-adjusted performance by looking at performance first and then selecting the best SD + Sharpe ratio funds.
In 2017, I changed it from owning 5 funds to just 2-3 funds, back to Bogle’s idea. BTW, Buffett said many times that most investors should use just one fund, the SP500, again, concentration and not over-diversification.
My system is not getting rich fast and/or use daily/weekly/monthly trades.
Why did it work a lot better than I expected?
1) The SP500 (or VTI) are great but not always. The SP500 lost money for 10 years during 2000-2010 while VALUE, International and SC were much better.
2) My biggest success was owning great risk-reward managed funds. This is my FREE LUNCH.
3) Retirement for most is the biggest challenge, most want/need to make a certain % without losing too much. Most can’t afford it unless they have a huge portfolio. Owning bonds sounds good but sometimes it’s far from being a protection, 2022 was a good lesson.
Examples:
2000-2010 I owned for 7-9 years SGIIX,OAKBX,FAIRX (https://www.portfoliovisualizer.com/backtest-portfolio?s=y&sl=sSHufzf3l9RXAe7QohdtF)
2010-2017 and preparing for retirement, I owned just PIMIX for all my bonds and eventually, it became over 50% of my portfolio. See PIMIX vs BND(Bond index) (https://www.portfoliovisualizer.com/backtest-portfolio?s=y&sl=79N44UoX477MCGXqb6cGdD)
PRWCX is another remarkable long term allocation fund, with a Percentile Rank in the top 1-3% for 3-5-10-15 years. (https://www.morningstar.com/funds/xnas/prwcx/performance)
Great article as usual Jonathan. I am struggling with having Fidelity managing my traditional and ROTH using their managed services. I should consider your suggestions and do it on my own.
JFYI – India’s growth rates are upwards of 6.5% with a large working age population for many more years to come (for those considering world stock index’s).
BTW Jonathan I would love to see an article from you on traditional to ROTH conversions, pro’s and cons’, when or if it should be done, tax consequences and whether to fund the conversion using the money from traditional or investment account (I am lob sided on traditional many folds and when my RMD kicks in 8 years, I will likely move to a much higher tax bracket and trying to avoid / remain in lower tax bracket).
Thanks for the comment. Here are two articles about my Roth conversions that you might find helpful:
https://humbledollar.com/2022/06/self-inflicted/
https://humbledollar.com/2023/01/juggling-for-retirees/
One of my key principles of investing is diversification. The top countries in this investment are below. Has anyone been following US politics lately? Yikes! I prefer not betting on the US with almost 2/3 of my assets for the long term.
United States 62.19%2Japan 6.29%3United Kingdom 3.52%4Canada 2.67%5France 2.59%
For many years I thought much as you apparently do now. I am greatly poorer for it.
It turns out, I’ve now learned painfully, that politics generally have little to no bearing on long-term capital markets, and when a correlation between politics and the markets can be seen, domestically or otherwise, things regularly go in the opposite direction to what might be expected.
The relevant question with an investment like VTWAX is whether or not capitalism will survive and whether the world economy will continue to function. If the answer is no, investments, whatever they are, will be the least of our worries.
Also, the word “lately” in your post indicates a perspective that might be troublesome to your financial future, but I’ll go about my day now! Happy Easter!
Robert-You and I share being poorer by not betting 100% on the “home team” during the last decade! But, as big a fan of indexing as I am, I just cannot go down the pure weighted average global market path, regardless of circumstances. As we know, this index stuff is still only 50 years old or so…..and we may be getting on some new ground. For instance, do we stay on the index path regardless and never take a “smell test”? , What if the Magnificent 7 goes from 30% to 50% of the US market? Or if the US market goes from 62% to 80% of the world market (where we are heading if we have another decade of US outperformance)? My second rule of investing, after “don’t put all my eggs in one basket” is that past performance is not always an indicator of future performance. I don’t have the right number but when the US market is now almost 2/3 of the world index, it is not passing my smell test for diversification…..and my hero, John Bogle, would probably think I’m nuts and agree with you!! One final word on the topic: JAPAN.
Hope the Easter Bunny was nice to you!!
Jim
PS Go USA! (It has usually not paid to bet against the home team)
Great article! I’m a little confused about the concern with the cost of Fidelity’s cash balance accounts. WIth FZDXX I am getting a 7-day yield of 5.16% and surely that is net of fees? I don’t think there are much better rates available elsewhere.
The fund has a $100,000 minimum — far more than I like to keep in cash:
https://fundresearch.fidelity.com/mutual-funds/summary/31617H805
Meanwhile, its yield is still 0.12 percentage point lower than Vanguard’s money market fund with a $3,000 minimum:
https://investor.vanguard.com/investment-products/mutual-funds/profile/vmfxx
Jonathan, I was surprised to read that 100k is “far more” than you like to hold in cash.
I went to the guide to be able to reference what you had said there on the subject in my comment. It seems you’re consistent 🙂
I may have too much, both total and in taxable accounts.
In case anyone else was also surprised, here’s the section from the guide. Short version: if you’re retired, you may not need any at all.
https://humbledollar.com/money-guide/how-big-an-emergency-fund/
Claiming the foreign tax credit (FTC) is just getting back the foreign tax that was withheld from the foreign dividends earned within your fund in a taxable account. If your tax filing status is MFJ and your foreign taxes exceed $600 ($300 if single) in 2024 from all sources then a form 1116 is also required with your 1040. Depending on your other income those taxpayers above the $600/$300 threshold may find their FTC limited to a lesser amount. When that happens you then have created a carry forward for the FTC that could not be used in the current year. The complex system we have determines determines the available FTC differently for regular tax and alternative minimum tax and you then have a separate AMT 1116 form and carry forward for the unused credit.
Even if your current year FTC is fully available in the current year you have to glean for separate input into your tax software the total foreign dividends, the foreign qualified dividends and perhaps the name of the country that imposed that tax. Note most tax software defaults for 1116 to using your broker statement total dividends which most likely is not equal to your foreign source dividends and the credit you claim could be inaccurate.
If you are paying a tax professional on a time basis it will take more time to prepare your return if a 1116 is required. If you have multiple broker statements with foreign tax withheld that will also increase the time and the FTC supporting schedules in your return.
Losing out on a small FTC by owning VTWAX could save you both time and money and certainly creates more simplicity in a taxable account. I do own VTWAX but I do so inside my retirement accounts. I am aware that I lose the foreign tax withheld for all such foreign investments held in my traditional and Roth IRAs and I am ok with that.
A key metric to look at with one’s foreign funds is the differential between the in-country withholding tax rate on that foreign source income that the fund is subjected to vs. your personal tax rate. If your US tax savings by having the fund inside the IRA wrapper outweighs the foreign tax you would otherwise have credited to you without it, then you would generally be better off tax-wise by having it inside a wrapper. For this reason I have, like yourself, included foreign funds inside a Roth for a number of years.
So if you own these accounts in retirement accounts, it sounds like it will cost more than it is worth to claim the FTC when it is time to withdraw the funds if you claim them on your tax return?
Bill, having just finished my tax return for 2023, and being one of the small minority that does it manually (no tax software), I can say that the two forms you reference, Form 1116 (FTC) and 6251 (AMT) gave me, as usual, the biggest headaches.
Form 6251 (AMT) is a doozy because you actually have to fill out the entire form in order to know….if you need to file the form!
Form 1116, and its accompanying Instructions, are mind boggling in their complexity. As you suggest, trying to take the 1099 figures you’re given and fit them into what the 1116 is calling for, is almost beyond me. I’m still uncertain what to do with foreign capital gains distributions. Aaargh….
In 2022 the error rate of the IRS to transcribe paper 1040 returns was north of 20% per the IRS taxpayer advocate. It will be interesting to see the results the IRS push in 2024 to process paper returns by electronic scanning will have.
I have been using the free file fillable forms (FFFF) online software for the last couple years which is basically doing your return by hand but avoiding potential IRS input errors. Not sure what I will do if they eliminate FFFF as they move to the IRS Direct File platform.
How about a new bill in congress requiring all members of congress to prepare their own 1040 with a pencil and a 10 key calculator. Maybe we could get some real tax reform.
I’ve also found the FTC is a pain to chase in tax prep software, but having only a foreign fund or two and no individual foreign stocks helps a lot.
It still seems worth the effort. And if going through the effort anyway, might it make sense to hold even more of one’s international fund holdings in a taxable account to take advantage of the FTC? I don’t know.
Congress could just raise the FTC limit from the current $600/$300 that requires a 1116 or just limit the credit to your tax. Note to congress – please do not fix by making the tax code more complex.
Great article and a lot of food for thought. I am trying to understand why one would do a bond fund like VSGDX (.5% gain YTD) versus using money market funds that offer 5.2% (Fidelity FZDXX for example). Interest rates seem to have to stay at this level or go up in the long term based on the debt in our country. I live in a low tax state as well (3%). Thanks!
If the Federal Reserve cuts short-term interest rates three times this year, as many expect, those rich money-market fund yields will soon be history. Those who think cash is a good long-term holding may be unpleasantly surprised.
But while they are higher, it’s better to be in cash. You can always go to bonds when cash yields go down
By then, longer-term interest rates may also have fallen, and you will have given up the chance to lock in today’s higher yields and enjoy some capital gains. Hanging out in cash investments until yields fall is not a slam-dunk.
If you are a follower of Bill Bernstein and believe if you “won the game stop playing” where do you keep those Monies?
I’m not going to look it up, but I believe the full caution from Bill B is if you’ve won the game, stop playing with money you really need.
Having won the game in my opinion doesn’t mean all the chips can come off the table. It does mean that if you’ve had sufficient growth that you can now reduce risk, then you should. Usually though, unless you’ve won Powerball, having “won” means having a sufficient amount that a reasonable portfolio, including some stocks, has a very high chance of carrying you through life and paying for your goals.
If your question ‘where do you keep those monies’ refers to where do you keep what comes out of stocks, I believe Bill recommends keeping something like ten or more years of living expenses in short term Treasury bonds.
My Roth accounts — which are earmarked for my kids — are 100% in Vanguard Total World Stock. My traditional IRA — which I view as my retirement spending money — holds both stocks and bonds.
BTW, while Bill is a good friend and while I may have won the game, I have no plan to “stop playing,” if that means retreating to an ultra-conservative portfolio. That strategy, in itself, carries risk.
Maybe, but if you won the game, being ultra conservative has no risk
What if you live longer than you ever imagined — or face much higher expenses than you expected? Every investment choice involves risk.
Thank you Jonathan!
Lots of great information and concepts. I’ll be pondering this one for a long while.
You say “Unlike the ETF, the mutual fund can be bought and sold without incurring trading costs”.
What trading costs are you referring to when you say mutual funds do not have them but ETFs do? I buy and sell ETFs at Vanguard with no trading cost.
Whenever you trade an ETF, you lose a little to the bid-ask spread — the difference between the higher price at which you can buy and the slightly lower price at which you can sell. That’s why, for money you expect to spend in the next few years, mutual funds are often the better choice — you incur slightly higher expenses but avoid the bid-ask spread. By contrast, for long-term holdings, ETFs are typically the cheaper choice, because the lower fund expenses compensate for the bid-ask spread you incur when buying and then selling many years later.
Exactly. That’s why I use ETFs.
Two reasons I limit my foreign exposure and only to taxable accounts. 1 – only about half of the total international fund dividends are qualified for tax purposes. 2 – I do appreciate the foereign tax credit and with a smaller percent of assets invested internationally I am able to make full use of it.
Charles, what does the percent of assets have to do with whether you can take full advantage of the foreign tax credit? Thanks
Btw re item 1 you might see my comment below.
Some of my best tax loss harvesting has been with my foreign fund. I could not have done as well harvesting VTWAX due to the superior returns in the domestic % of the fund. I also agree that being able to adjust the % of foreign to domestic is an advantage.
Here’s another consideration. For a taxable account, you may want to choose a fund that follows a large cap developed market index. Most of its dividends will be qualified, while a good chunk of those from a fund that follows a total international index will not be.
As an only slightly more complicated alternative to VTWAX, what about holding a combination of VTSAX and VTIAX? This would allow choosing one’s own ratio between US and international stocks, rather than the 40+% international holdings of VTWAX (a bit much for my own taste). Also, if the domestic side is a strong majority of the combination, the total expense ratio would be less than VTWAX, though perhaps not enough to make that aspect decisive. Last, the two fund combination would contain a significantly greater number of stocks, unless my interpretation of the Vanguard comparison tool is faulty.
But if utter simplicity still rules the day, I agree that VTWAX is primo!
On the simplicity front, here’s one more reason to favor VT/VTWAX: While separate total U.S. and total int’l funds will likely require rebalancing between the two, that’s not an issue with Vanguard Total World Stock — though you may need to rebalance between that fund and bonds.
Apparently, I’m a masochist. I actually enjoy rebalancing, and with more funds than two!
Welcome to our new site…. HumbleMasochist.com!
In bond funds, some may prefer Vanguard’s VSBSX to VSGDX. VSBSX has a lower minimum for those starting out ($3k vs $50k). VSGDX holds some bonds not “backed by the full faith and credit of the U.S. government”. And there’s an average duration difference to consider. VSBSX is also slightly cheaper, though both are already pretty cheap compared to bond funds at companies beyond Vanguard.
Jonathan, may I ask about your thinking in selecting VSGDX for the non-TIPS part of your bond holdings?
Also, do you tilt one way or the other between TIPS and non-TIPS?
The fund should deliver a slightly higher long-run return than a pure Treasury fund, but with only scant more risk. Put it this way: If VSGDX is suffering bond defaults, financial Armageddon is upon us and it really won’t matter what you own.
How ’bout Charlie’s TIPS question, Jonathan? I’m curious too now. For me, TIPS are about one-fifth of my bond allocation.
I aim to split my short-term bond money evenly between the short-term TIPS fund and the conventional government bond fund.
Thank you.
I learn something every time! I didn’t know about splitting the foreign and U.S. holdings in taxable accounts. Unfortunately I think it doesn’t make sense now to split my world index fund up (URTH, which racks developed markets) because of the cap gains I already have.
Therein lies the rub… I had the same problem years ago. I was invested all over the place with different fund companies (last year’s big winners as touted in various magazines) then I saw the light and switched to Vanguard. Bad news: I had that capital gains situation. Good news: I course corrected early enough that was positioned for the long term.