Favorite ETFs for Investors Under 40
04/20/2015 10:00 am EST
David Fabian of FMD Capital explains the benefits of quality exchange-traded funds for investors with a long investment time horizon. Here, the money manager discusses his favorite ETFs for those under 40, covering stocks and bonds offering domestic and international exposure.
Steven Halpern: Our guest today is money manager David Fabian of FMD Capital. How are you doing today, David?
David Fabian: I’m wonderful, Steve. Thanks so much for having me today.
Steven Halpern: Well, thank you for joining us. You recently wrote a fascinating article focused on investors under 40 years old. Before we look at some specific investment ideas you suggest, could you explain in general how the investment goals of someone in their 30s should differ from an older investor?
David Fabian: Absolutely. You know, I think you really have to separate the investors that are sort of in the growth and compounding years of their lifecycle versus the investors that are a little bit older, moving towards retirement, and are more in the capital preservation and income side of their lifecycle.
And so, being that I’m actually in my mid-30s myself, so I’m very kind of familiar and feel confident, kind of, speaking for this group, but we’ve got investors under 40 that really focus on, you know, they might be saving for a home, they’re certainly investing for retirement. They’re potentially looking at growing their kids’ college education fund, or saving for other things that they want in their lives, and long-term goals of that nature.
Steven Halpern: Now you suggested exchange-traded funds make a perfect investment vehicle for investors in this younger age group. Could you expand on that?
David Fabian: Yes, you know, ETFs have really come a long way over the last couple of years. We have used them almost exclusively in our money management practice here at FMD Capital Management. An ETF is really just a low cost index fund.
Some of the advantages include: complete transparency of the underlying holding, they’re extremely liquid, which means you can buy and sell them throughout the trading day. They’re very tax efficient because they track a path of index and so they’re not doing a lot of portfolio turnover and generating a lot of tax gains and losses at the end of the year. And they also provide a very high degree of diversification, which is very attractive.
Instead of trying to take individual stock, you can really select an ETF to hone in on a specific industry group, or a sector, or even a broad based index like the S&P 500.
Steven Halpern: Now, in this latest article, you’re highlighting some passively managed ETFs as opposed to the more aggressively managed ones. Could you explain your reasoning for choosing those?
David Fabian: You know, passive ETFs make a really good core of your investment portfolios. As we kind of look back over the history of the stock market, you know, my parents really grew up investing in high speed mutual funds, and as we kind of look at the returns over time, most—really, four out of five actively managed stock mutual funds—have been unable to outperform their benchmark.
And what is their benchmark? That’s essentially an exchange-traded fund. It’s the passive index that they’re trying to be, and so, really, passively managed ETFs with the extremely low expenses that they have, they provide excellent diversification as I mentioned.
These are kind of the future of investing and what I feel like is one of the best options for investors that are saving, compounding, and growing their wealth over time.
Steven Halpern: Turning to some specific ETF ideas, you highlight the Vanguard Growth ETF with the symbol (VUG). What do you like about this ETF?
David Fabian: Well, VUG is composed of about 370 large-cap stocks. Some of the top holdings of course include Apple, Google, Facebook. It’s a very technology heavy index, but I really like it because it also includes a wide breadth of other sectors as well, so you’re getting some consumer discretionary stocks, you’re getting some healthcare companies, you’re getting some financial companies.
These are really companies that are focused on growing their top and bottom line to support new product and innovations of the future. Some of the best companies within the large-cap S&P 500 index are going to be represented in VUG. Of course, because it’s a Vanguard ETF, it has a very low expense, has an expense ratio of nine basis points, 0.09% on annual basis, so it is an extremely low cost, liquid ETF.
There’s almost $20 billion in assets in this fund and I just think it has a very strong track record as well. As we’ve looked back over the last five years, it has actually outperformed the S&P 500 by a little over 1% over the last five years on an annualized basis, so I think there’s a lot going for VUG as a large-cap growth option for younger investors.
Steven Halpern: Now, also on your list is Vanguard Extended Market ETF with the symbol (VXF). What is the attraction with this one?
David Fabian: You know, this one is a little bit less well known than some of the other funds out there. The reason I chose it is because I’m all about simplicity. A lot of investors, when I kind of mention the large-cap allocation VUG, now they’re going to start thinking about filling in the rest of their portfolio with small- and mid-cap exposure as well.
Instead of selecting a small-cap fund and a mid-cap fund, VXF actually combines the two of them together, so it’s actually made up of a little over 3,000 small- and mid-cap stocks, again, very well-known names; Tesla Motors, Las Vegas Sands, American Airlines, these are some of the top holdings in the ETF, but small- and mid-cap stocks, they’re great for long-term growth in a portfolio.
They’re a little bit more aggressive than large-cap, but I think it’s a good way to diversify your portfolio out as the fact that single fund owns over 3,000 companies, provides a very high level of diversification, and again, the expenses on annual basis is just 0.10%, so, extremely low cost, extremely diversified, and a good overall mix of small- and mid-cap companies that you can add to your portfolio in conjunction with VUG to kind of make up a full allocation to domestic stocks.
Steven Halpern: A third pick of yours in the Vanguard family is a more specialized fund and it’s the Vanguard REIT with the symbol (VNQ). What’s the story with this real estate related fund?
David Fabian: Yes, REITs—or real estate investment trusts—are, sort of, an alternative asset class, kind of an unconventional strategy compared to traditional stocks and bonds. I think it’s important for investors to have, you know, a very broad approach to their portfolios.
Its non-traditional assets like REITs, they can help you enhance your portfolio yield. They can also increase returns over time as they sort of balance out the volatility of other positions in your portfolio.
I’m not a fan of private REITs. They tend to be very illiquid, but publically traded real estate investment trusts can be an excellent way for liquidity and an attractive dividend stream for your portfolio.
VNQ invests in about 140 real estate investment trusts. These are retail companies, residential, healthcare offices, mall REITs, you know, they’re very big real estate companies.
Public storage is an extremely large holding within this ETF. Right now, it has a yield of about 3.4%, and again, this fund at Vanguard has extremely low expenses, and I’m very cognizant of keeping costs low in a portfolio as you’re compounding over time that’s going to help increase your returns, so the high yield, the favorable diversification, make this a very attractive fund to own in your portfolio as well.
Steven Halpern: Now, you also recommend that younger investors look beyond the domestic markets and you suggest two ETFs that offer global exposure; the iShares Core MSCI Total International Stock with the symbol (IXUS), as well as the iShares MSCI EAFE ETF—that’s a mouthful—with the symbol (EFA). Could you explain these positions?
David Fabian: Certainly. You know, EAFE is actually the largest international ETF currently trading right now. It has tens of billions of assets under management. The EAFE index is an extremely well known index of international stocks.
EAFE stands for Europe, Australia, and the Far East, so it is essentially trying to mimic a diversified basket of stocks outside of the United States, really, overseas in many of those countries and there’s about 900 stocks in EFA. It’s a very nice liquid fund.
Many people own this, but the fund I’m actually recommending for investors under 40 is a little bit more diversified. The IXUS—the iShares Core MSCI Total International Stock Index—provides returns similar to EAFE, but it also includes a broader range of countries and individual stocks as well.
There’s about 3500 individual stocks in IXUS—and what it does is—it includes Canada and South America as well, so you’re getting countries like Brazil, you’re getting countries like Argentina and other areas of South America in there as well.
So, it’s really a broader look at the global market outside of the United States, which I think, again, enhances diversification, has an extremely low expense ratio, just 0.14%, which is very low for an international fund, so I think it gives you some very nice allocation to some global growth themes.
Steven Halpern: Now, finally, you highlight a fund that mixes both stocks and bonds, as well as domestic and international stocks, the iShares Core Growth Allocation ETF with the symbol (AOR). This seems to be a one-stop shop for long-term investors. Could you share your thoughts?
David Fabian: Absolutely. You know, really, a lot of folks either like to, kind of, consolidate their investments down to fewer holdings or they potentially have smaller accounts, where they only want to own one or two ETFs in them. AOR makes the perfect holding for those. It might be a little bit more conservative, because it does own stocks and bonds in it.
What it is, right now, it is essentially a 60% weighting in domestic and international stock and a 40% weighting in high quality bonds as well. You’re kind of getting that very global diversification in the stock portfolio. You’re getting some high quality bonds to kind of offset the volatility as well.
You mentioned it’s sort of a one-stop shop for all of your portfolio needs. The fact that it is a growth-oriented ETF means it is going to have a little bit higher weighting—that 60% weighting in stock—which a lot of people recommend.
60% stock, 40% bonds is a very common asset allocation strategy for many people in their growth and wealth accumulation years, and so, I feel this is a very strong, low cost option for people that are sort of looking for that one ETF that they can plug in at the core of their portfolio and really hold for the long-term.
Steven Halpern: Again, our guest is David Fabian of FMD Capital. Thank you so much for taking the time today.
David Fabian: I appreciate, Steve. Thanks for having me.