- 01KISS: 1–3 ETFs, set-and-forget.
- 02ETFs offer diversification and liquidity.
- 03One-stop: VDHG or DHHF for broad access.
- 04Quarterly rebalancing keeps target mix.
When it comes to investing, the trusty old KISS principle (keep it simple, stupid) applies just as much as it did for designing easy to repair aircraft.
Human beings are good at making things more complicated than they need to be, and investing is certainly ripe with unnecessary complexity and difficult to understand concepts.
So, imagine if you could achieve all of the major investment aims – liquidity, diversification, and market returns – with a really simple and understandable investment strategy.
Using ETFs for Diversification
It turns out that anybody can do that using one of the simplest but most profound investment tools ever created – the ETF or exchange-traded fund.
In striving for a really simple and understandable investment plan we want to use the smallest number of ETFs possible—as few as one, or at least no more than three.
What this simplicity allows for is making the investment process very easy to understand.
Once there is cash available for investment it is just applied to the ETFs and becomes a set and forget plan.
Similarly, when dividends are paid from the ETFs, a simple decision can be made to buy more or to use the money in other ways.
Searching for the Holy Grail
To arrive at the ultimate KISS investment, it would be great if we could just stick to one ETF and use that for everything.
It would need to provide diversified access to Australian and global markets which was rebalanced a little over time to prevent one sector overwhelming the others and it would need to have low costs.
It turns out that some of the big ETF providers have been working on just such a single ETF, although picking the right one for you is something of an individual choice because some entail more risk/reward than others.
However, in the interests of keeping things simple, let’s just look at one that might do the trick – the Vanguard Diversified High Growth Index ETF (ASX: VDHG).
As requested, it combines Australian and international shares and has smaller allocations to defensive assets.
It also rebalances every quarter so that it remains true to its target asset allocation – that is, the percentage of assets in each market, so that no geographical area or market sector dominate too much.
Another alternative which is quite similar to VDHG is BetaShares Diversified All Growth ETF (ASX: DHHF) which has a slightly lower management fee but is broadly comparable.
One option for those who have a lower risk tolerance and want to increase the percentage of defensive assets such as bonds is Vanguard Diversified Balanced Index ETF (ASX: VDBA).
VDBA is identical to VDHG but only has a 50% exposure to growth assets (compared to 90% for VDHG), with the remaining 50% invested in bonds.
A Touch of Control
Keeping it simple is one thing but sometimes we humans want to exert a little bit more control over what is happening with our investments but still want to have an investment portfolio that is really easy to understand and monitor.
Rather than using a single “holy grail” ETF, we are going to separate out some of the components so that we can individualise our approach a little.
So, if we feel that the Australian dollar is on the rise, for example, we might want to dial up our exposure to international stocks by buying more of them and less Australian stocks.
Or, we could decide to add something like exposure to emerging markets to the mix.
Complications Can Develop
Beware though, complicating matters like this adds its own penalty in the form of more decisions to make, more administration to consider and perhaps a less-focused approach than using a “Holy Grail” type ETF.
Sticking with Vanguard for a moment, the combination would be Vanguard Australian Shares Index ETF (VAS) for Australian exposure and Vanguard MSCI Index International Shares ETF (ASX: VGS) for international exposure.
By moving the balance between the two ETFs a little, you could follow your desires for more or less offshore exposure, depending on your own research.
There are many alternatives to the Vanguard duo, most giving similar but not identical exposure with minor differences also in management fees.
For Australian exposure some of the options would include the State Street SPDR S&P/ASX 200 ETF (ASX: STW), BetaShares Australia 200 ETF (ASX: A200) and iShares Core S&P/ASX 200 ETF (ASX: IOZ).
International alternatives include iShares Global 100 ETF (ASX: IOO), and perhaps Vanguard All-World ex-US Shares Index ETF (ASX: VEU).
US market funds such as iShares S&P 500 ETF (ASX: IVV) and Vanguard Morningstar US Total Market ETF (ASX: VTS) are something of a proxy for global shares, given the global dominance of the US market but obviously miss out on other big markets like Europe and Japan.
Thorny Issues Arise
This is where we see the thorny issues starting to arise when we start to complicate things.
Do we start to look at hedged exposure to reduce the impact of currency, do we start to consider actively managed ETFs?
What about high dividends, private markets, hedge funds or do we look to pick and choose our bond exposure as well?
All of these are great examples of complications sneaking in to undermine the KISS principle that we started with.
What we have demonstrated is that it is possible to have a diversified global exposure to share markets in a single ETF, and even to actively manage our global exposure by using just two ETFs and changing how much of each we hold.
Investing can be made quite simple and still be comprehensive and diversified.
We can certainly complicate the picture endlessly if we want to but there is precious little evidence that doing so will add meaningfully to returns or reduce risk.
Get the wire before the market opens.
The ASX small-cap stories that matter, filed before 9am AEST. Curated by the Small Caps desk.