Credit: Shutterstock photoLet’s play a little hypothetical investment game. I’m going to give you $100,000 in cash today, but there are two unbreakable conditions. The first is that you must put it into only two exchange-traded funds (ETFs). The second is that you can’t touch it for ten years.
It’s an interesting thought experiment when you view it outside of your current investment paradigm. You are starting with a fresh slate of money that has never been invested before. That means you can put it in any of the 2,100+ available ETFs without disturbing other long-held positions. You are also able to free yourself of any adviser, custodial, or other relationships that may influence your present-day decision making.
Where would you go? What would you choose?
Let’s set position sizing aside for the minute and focus on security selection. For many the answer would be easy. They would immediately default to the low-cost pairs trade of the Vanguard Total Stock Market ETF (VTI) and Vanguard Total Bond Market ETF (BND), or some other facsimile of the same.
The benefits are minimalist expense structure, highly diverse holdings, full transparency, tax-efficiency, and deep liquidity. These funds also have proven track records from a world-class ETF sponsor that is all but guaranteed to be here ten years from now.
Yet, there are also some drawbacks to this approach as well. It’s glaringly lacking any international exposure, and from a pure risk standpoint, doesn’t pack any excitement. There is little to offer in the way of unique positioning that would create alpha above the benchmark or potentially guard against high probability risks.
Others may choose a different route by combining the necessity of a low-cost passive index with a smart beta vehicle for added emphasis on a specific facet of the market. This gives you the best of both worlds in that you have a portion of the portfolio dedicated to core exposure with a secondary allocation to capture an investment dynamic you believe to be a future star.
That may include a quantifiable factor like value or momentum, a sector you love for explosive growth over the next decade, or even an ETF weighting methodology that has proven to be a success. Many investors have differing preferences on where the best opportunities in these areas to be.
My personal tastes run towards ETFs with multiple factor and global investment criteria such as the Alpha Architect Value Momentum Trend ETF (VMOT) or the Cambria Global Momentum ETF (GMOM). Both funds offer a “fund of funds” approach that allocates capital based on areas demonstrating strong relative momentum. This includes a global focus with a significant exposure to a diverse group of international holdings.
Furthermore, some aggressive risk-takers would bet the farm on a highly specialized thesis with an ETF designed to benefit from the trend. Some examples might include hyperinflation, rising interest rates, declining stock prices, or an emerging theme like bitcoin, marijuana legalization, or even cybersecurity.
Such a niche strategy would likely carry high costs and the greatest skew in terms of overall performance. It’s either going to be very right or very wrong depending on the timing and returns of the chosen asset class. Remember that the money can’t be traded in or out once you make the selection for a 10-year period. It changes your behavior significantly when you ponder that one restriction.
The Bottom Line
Long-term investors would be wise to contemplate this process every few years to determine if they are in the right holdings even if they aren’t currently the top performers. If given the chance, would you buy everything you own again with the expectation that it’s going to meaningfully contribute to your future goals?
The answer is likely to prompt confidence in your existing strategy or the contemplation of a new path. I would stress that any meaningful portfolio shakeups should be carefully planned and executed using evidence-based judgement.
Disclosure: At the time this article was written, the author owns shares of VMOT and GMOM.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
