OUR CONTROL GROUPS
It wouldn’t be very useful of this blog to simply come online and say we got a return of X% from a particular alternative investment. Well, it would be useful, but it would leave you with the second question of, is X% good?
Index investing is endorsed by most of the brightest and successful minds in the history of investing:
Jack Bogle, the founder and past CEO of The Vanguard Group, has said: Don't look for the needle in the haystack. Just buy the haystack!
Warren Buffet, the founder and current CEO of Berkshire Hathaway, has said: The goal of the non-professional should not be to pick winners — neither he nor his 'helpers' can do that — but should rather be to own a cross-section of businesses that in aggregate are bound to do well. A low-cost S&P 500 index fund will achieve this goal.
With this in mind, we will be picking a handful of index funds to use as comparators for our more exotic investments. At the same time, we want to try and track mutual fund and hedge fund performance, too, to continually belabour the points made in our earlier post (The Scary Truth About Mutual and Hedge Funds Fees).
We’re happy to take suggestions about some traditional investments to track in the future, but to begin with, we’ll use the following:
Risk free rate of return
The risk free rate of return is, just what the name implies: the theoretical rate of return one would receive if there was zero risk to the investment. This is a theoretical rate because there is no such thing as “risk free”. Anytime you entrust your money to someone else, whether it is a business, a bank or a family member, there is always a chance you could lose your investment. That said, the traditional standard for “risk free” in the 21st century is the rate of return on government bonds issued by the U.S. government (AKA T-bills), because they are backed by the U.S. government, which is interpreted as providing a nearly zero risk of default.
We are going to start off by keeping track of the Vanguard Short-Term Government Bond ETF. This is an ETF designed to track the Bloomberg Barclays US Treasury 1–3 Year Bond Index, which includes fixed income securities issued by the U.S. Treasury with maturities between 1 to 3 years.
For more information on this ETF, check out its profile: https://investor.vanguard.com/etf/profile/VGSH
If the goal of an investor is to be a true index investor, as the smart investors tell us it should be, then the goal should be to buy the broadest set of assets possible at the best possible price. When it comes to breadth, there is nothing broader than a global equity tracking fund, with the goal of finding the index that gets as close as possible to having some kind of interest in every company on every stock market in the world. And when it comes to fees, as was discussed in our post on Active Vs Passive Funds, it is hard to beat ETFs.
Enter the Vanguard Total World Stock ETF trading on the New York Stock Exchange. This fund has everything going for it, with holdings in 8,109 different stocks and a razor thin management expense ratio of just 0.10%. A look at its regional allocation shows us a fair estimate of the distribution of stock market investment worldwide:
North America 57.90%
Emerging Markets 9.20%
Middle East 0.20%
The ten largest companies in the ETF will not be a big surprise to investors the world over. They are a who’s who of the world’s leading companies:
Amazon. com Inc.
Alphabet Inc. (i.e. Google)
Berkshire Hathaway Inc.
JPMorgan Chase & Co.
Johnson & Johnson
Exxon Mobil Corp.
Bank of America Corp.
That said, while many or most investors who are in the North American market own these shares, maybe in large portions, in the Vanguard Total World Stock ETF, they only represent 10.7% of its total holdings.
For more information on this ETF, check out its profile: https://investor.vanguard.com/etf/profile/VT
And last but not least, everyone’s favourite benchmark, the S&P 500. This index is considered by many to be the gold standard of investing. And to be fair, the S&P 500 is pretty remarkable. The Standard & Poor’s 500 is an index which tracks 500 of the large companies listed on the New York Stock Exchange or the NASDAQ Stock Exchange (with companies having a total market capitalization, or value of outstanding shares, in excess of $4 billion).
The stocks are selected by a committee, and the index is frequently referred to in the news media and financial literature as the best benchmark with frequent comments comparing any other returns to it.
To be fair, thus far, the S&P 500 has earned its reputation as the gold standard. It was created in 1928, and for the last 90 years it has averaged 9.7% returns, which is kind of ridiculous. While I would argue that a global equity index is still the best kind of diversification, the prevalence of the S&P 500 in the average investors psyche makes it too hard to ignore, and so we’ll be using the Vanguard S&P 500 ETF to keep track of its performance.
Not surprising, the Vanguard S&P 500 ETF has the exact same top 10 as the Vanguard Total World Stock ETF, however, where the world equity ETF top 10 represent only 10.7% of the total value, in the S&P 500 ETF those same 10 stocks represent 23.3% of the total value.
For more information on this ETF, check out its profile: https://investor.vanguard.com/etf/profile/VOO
For anyone who read our first monthly update on November 1st (October 2018 Fiscal Frontiers Update), you'll recognize these ETFs as those we discussed in that earlier post.
Now that we have laid the groundwork for what we will use as our “control group” going forward, we can start to look at some of the alternatives. First up, staying at least in the same realm, we will look at a hybrid passive/active option and a glimpse of the future: handing your money over to robots to invest!