Totally Your Choice

Jonathan Clements

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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