So where do we go from here (as Bobby Womack so beautifully sang)? Warren Buffett, as usual, has the simplest solution; put 90% of your savings in an S&P 500 index fund and 10% in a bond fund.
A quick reminder, taken straight from the Morningstar web site, “The S&P 500 is the most oft-cited proxy for the U.S. equity market and is viewed as an indicator of the economic health of the nation. Although not as old as the Dow Jones Industrial Average, the S&P 500 is better diversified and market-cap-weighted, which makes it more representative of the U.S. market.” As mentioned here many times, the S&P 500 is my preferred measure of U.S. markets. And it has historically gone up more often than it has gone down.
Note the S&P index is capitalization weighted, which in plain English means the bigger the company, the larger a percentage it comprises within the index. For example, Apple (AAPL) is one of the biggest companies in the world and as such has the biggest weighting in the S&P index. AAPL makes up almost 3% of the total holdings in the S&P index, while Pepsi (PEP) constitutes less than 1% of the total holdings. Simply put, if AAPL has a bad day, it has a bigger impact on the total value of the index than if PEP takes a hit to its share price.
Now, I’ll suggest for most folks VOO is a better holding than SPY – explained below – but for those wanting something a little less plain vanilla, there is also RSP. And this is where the fun starts, understanding and choosing between ETFs that look alike, but really aren’t. SPY is the oldest and largest of the S&P ETFs, though to quote Morningstar, “structural issues hinder its efficiency.” It is also the most widely traded ETF, consistently matching the daily volume of Apple (AAPL). It charges 0.09%, which is half of what it charged when launched in 1993. But us individual investors should focus on lowest cost, not the best liquidity.
Vanguard offers VOO, with a lower cost (0.05%) and better track record matching the returns of the S&P 500 index over time. This remains the core holding in all of the accounts I manage, with VOO typically comprising at least 50% of the portfolios. And while there are no plans to sell any current holdings of VOO, as I add shares, I’m now selectively buying Guggenheim S&P 500 Equal Weight (RSP), with expenses of 0.40% for some accounts. Why pay the higher fee for an S&P fund?
A couple of weeks ago, the S&P 500 was down 0.33% and both VOO and SPY were down 0.37%. RSP was up 0.18%. The two biggest holdings in the S&P 500 index are AAPL and Microsoft (MSFT), both of which, for different reasons, took a hit to their share prices. The perfect example of why capitalization weighting has its problems. Time has tended to favor RSP over the big boys. On the other hand, RSP pays a lower dividend than SPY or VOO.
Interestingly, since starting this series on ETFs I’ve been asked specifically by different readers where to put $5000 to $10,000 today, right now. Note that after one of the most volatile markets in memory – the worst start to a year for the S&P 500 ever, followed by a breathtaking rally in the Spring, and now Great Britain collectively loosing its mind – markets are simply back where they were at the beginning of this year. It could easily be argued that the turmoil in Europe is going to be good for the U.S. since where else is safer to invest? Of course there is the wackiest presidential election of my lifetime to survive…
To Buffett’s point, for folks starting out, or just making some moves to invest this year’s IRA money, simple is best. With any rise in interest rates likely off the table this year, 90% in VOO and 10% in SHY sounds about right. If you already have a well-diversified portfolio, you might consider a couple of bets for the mid-term. Companies that tend to make most of their money in the U.S. are an interesting idea.
On Friday, at down 500-points on the Dow Jones Index, I bought some XLY, a consumer discretionary indexed fund with top holdings that include Amazon and Home Depot. This is a bet on America. I also purchased a slug of RSP at the same time. And for those with a bit more cash to park, well, Berkshire Hathaway is as all-American as it gets, and at $140, it’s looking pretty good (BRK.B). That is after all where Mr. Buffett keeps most of his investable assets.