How to Build Diversified Portfolios With Low-Cost Vanguard Funds

Have you ever wished you could build your own portfolio of low-cost index funds, the same way investment managers, and robo-advisors do?

Well, you can use simple low-cost Vanguard portfolios, based on their low-cost index funds.

You can do this through a Vanguard brokerage account, or with other popular brokerage firms, like Charles Schwab, that has one of the largest selections of low-cost index fund available, including Vanguard funds.

Why Vanguard Index ETFs

There are several reasons to invest in Vanguard exchange-traded funds:

  • Vanguard is the largest mutual fund company in the world, and the second largest provider of ETFs. This gives you tremendous investment flexibility. You can choose virtually any type of fund, in any category or sector you want.
  • There are no trading commissions when you buy and sell ETFs in a Vanguard brokerage account.
  • Vanguard’s funds are so popular, they’re commonly used by robo-advisors in constructing portfolios for their investors.
  • Low expense ratios. This rates a discussion all it’s own…

Low expense ratios

The average expense ratios for all ETFs is 0.44%, resulting in an annual cost of $4.40 per $1,000 invested.

Here's the best part:

Vanguard's expense ratios are among the lowest in the nation.

In the next section, we’ve provided a table listing 10 recommended Vanguard ETFs.

The expense ratios range from 0.04% to 0.14%. So let’s call it an average of 0.09% for all 10 funds.

Next, let’s compare a $100,000 investment in the 10 Vanguard ETFs with an investment of 10 “average” ETFs. We’ll assume each group of funds has an average annual rate of return on a 10%.

How much will the difference between expense ratios for the two groups of ETFs make over 20 years?

Average ETFs

The net annual yield on this group of ETFs will be 9.56% (10%, less the average 0.44% expense ratios).

After 20 years, $100,000 invested in this group of funds will grow to $620,927.

Vanguard ETFs

The net annual yield on this group of ETFs will be 9.91% (10%, less the average 0.09% expense ratios).

After 20 years, $100,000 invested in this group of funds will grow to $661,827.

Simply as a result of investing in the lower cost Vanguard group of ETFs, your portfolio will be worth $40,900 more.

Look:

That’s a lot of investment improvement just as a result of making a strategic decision to invest with lower cost funds.

Now Vanguard is not the only investment company offering indexed funds with very low expense ratios. But they have a very large number of low-cost index funds designed for virtually every market in existence.

This gives you the advantage of being able to choose any fund you wish, even if you’ve already built a strong core portfolio.

When you add Vanguard’s policy of no-commissions on its own ETFs, you’ve got a combination offering the lowest index fund investment strategy anywhere.

10 Funds to Build Your Own Portfolio

In this section, we’re going to examine the possibility of creating your own low-cost investment portfolio using just a handful of Vanguard index funds.

This is exactly what robo-advisors do, and you can duplicate the strategy on your own.

For this exercise, we’re going to use the following 10 Vanguard index funds to build several different portfolio types:

Vanguard ETFs and Expense Ratios

Vanguard ETF Ticker symbol Expense ratio
Vanguard US Stock Market VTI 0.04%
Vanguard Small-Cap VB 0.05%
Vanguard FTSE Developed Markets VEA 0.07%
Vanguard FTSE Emerging Markets VWO 0.14%
Vanguard Total Bond Market BND 0.05%
Vanguard Total International Bond BNDX 0.11%
Vanguard Short-Term Inflation Protected Securities VTIP 0.06%
Vanguard High Dividend Yield VYM 0.08%
Vanguard REIT VNQ 0.12%
Vanguard Global ex-US Real Estate VNQI 0.14%

Building portfolios using low-cost Vanguard funds

Before you even begin to build your own portfolio, there are four factors to consider:

  1. Your goals – what is it you want your investment portfolio to do for you? Retirement? Pay off your mortgage early? Fund your children’s college educations?
  2. Your time horizon – how many years do you have to reach your investment goal(s)?
  3. How much you have to invest, both upfront and by regular contributions?
  4. Your risk tolerance – how much are you prepared to lose in pursuit of your investment goals?

The first three factors are pretty easy, since you can choose the first, and the next two are basically math related.

But risk tolerance is much tougher.

Everyone wants to make money investing, but not everyone has an equal tolerance to sustain investment losses.

And though the financial markets have been almost straight up over the past nine years, losses are always a possibility.

Now:

You have to determine how comfortable you might be with losses of say 10%, 20%, 30%, or even 50%.

Exactly what level you would consider tolerable will help you decide how conservative or aggressive you can be in building your portfolio.

You can even take the risk tolerance quizzes given by different robo-advisors to help you make this very important determination.

With that in mind, let’s work to construct three portfolios, designed for risk tolerance levels of:

  • conservative risk
  • moderate risk
  • aggressive risk

Conservative Portfolio

This is a portfolio you might construct if you have a very low-risk tolerance. or if you’re very close to retirement or some other investment goal.

For example, if you would be uncomfortable sustaining a loss of more than 10% in your portfolio, you’ll want to favor stable, income-producing assets over pure growth funds.

Your portfolio might be constructed something like this:

  • Vanguard Total Bond Market – 20%
  • Vanguard High Dividend Yield – 20%
  • Vanguard FTSE Developed Markets – 10%
  • Vanguard Short-Term Inflation-Protected Securities – 10%
  • Vanguard US Total Stock Market – 20%
  • Vanguard FTSE Developed Markets – 10%
  • Vanguard REIT – 10%

This portfolio mix will emphasize both safety of principle, and its steady income, with a 60% allocation in the first four index funds (bonds).

But you also have exposure to the U.S. stock market, as well as a lower exposure to foreign developed markets.

The 10% real estate allocation would provide some protection against inflation.

Moderate Portfolio

This would be a portfolio if you were able to take on greater risk, while still emphasizing protection of principle.

Your portfolio might be constructed something like this:

  • Vanguard US Total Stock Market – 25%
  • Vanguard Small-Cap – 15%
  • Vanguard FTSE Developed Markets – 10%
  • Vanguard FTSE Emerging Markets – 10%
  • Vanguard Total Bond Market – 10%
  • Vanguard High Dividend Yield – 10%
  • Vanguard FTSE Developed Markets – 10%
  • Vanguard REIT – 10%

This portfolio mix will give you a 60% in stocks, 30% in income-producing assets, the 10% in real estate.

You’ll be able to fully participate in growth, but with some downside protection from the income-producing portion of the portfolio.

Aggressive Portfolio

This would be a portfolio in for a young person with a very long investment time horizon.

Since there would be plenty of time to recover investment losses, you can afford to be more aggressive. This portfolio will emphasize growth over income and safety of principle.

Your portfolio might be constructed something like this:

  • Vanguard US Total Stock Market – 30%
  • Vanguard Small-Cap – 20%
  • Vanguard FTSE Developed Markets – 15%
  • Vanguard FTSE Emerging Markets – 15%
  • Vanguard Total Bond Market – 10%
  • Vanguard REIT – 5%
  • Vanguard Global ex-US Real Estate – 5%

This portfolio mix will give you 80% in stocks, 10% in bonds, and 10% in both U.S. and international real estate.

The portfolio mix is aimed squarely at growth, with only a small allocation to safety, as well as inflation protection.

All three portfolio scenarios are just examples.

You’ll have to decide for yourself what will work based on your investment goals, time horizon, and risk tolerance.

It will be a little different for everyone.

Target Date Funds: An Even Simpler Approach

If you don’t want to construct your own index fund portfolio, you can always go with target-date funds.

These are sometimes referred to as a “fund of funds”.

They’re designed specifically to grow your portfolio over a specific amount of time to meet a certain goal or target.

They’re typically based on a specific year.

For example, if you want to retire in 20 years from 2020, you would select a target date fund dated for 2040.

The fund will automatically be adjusted as you get closer to your goal.

For example, early in the term, the portfolio will be more aggressive. But as you move toward the target-date, it will become more conservative.

Examples of target date funds offered by Vanguard include:

You can select any of these funds, based on your anticipated year of retirement.

Final Thoughts

As you can see, you can use low-cost Vanguard index funds to build your own portfolio, just the way professional investment managers and robo-advisors do.

And if you decide against building your own portfolio of funds, you can always opt for target-date funds instead.

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