ETFs: Keep it Simple

05/09/2016 12:00 am EST

Focus: ETFs

David Fabian

Managing Partner, FMD Capital Management

David Fabian worries that investors are overcomplicating their ETF portfolios; instead, the money manager at FMD Capital suggests a streamlined approach focused on basic asset allocation principles. He also highlights some favorite ETFs that are suitable as core building blocks of a long-term portfolio.

Steve Halpern:  Joining us today is David Fabian, fund expert and money manager at FMD Capital, as well as editor of the Flexible Growth and Income Report.  How are you doing today, David?

David Fabian:  I’m wonderful, Steve, thanks so much for having me back.  

Steve Halpern:  Well, thank you for taking the time.  At this week’s Money Show in Las Vegas, you’ll be conducting a workshop on building a bulletproof ETF portfolio and you suggest this involves three main themes; the first of those is simplicity.  Could you explain what you mean by that?

David Fabian:  Absolutely!  Well, first I just want to say I’m extremely excited to be speaking at The MoneyShow; it’s actually going to be my first event actually presenting there.  

I’ve been coming to Las Vegas and this event for a number of years and have always enjoyed it, but to be able to share my thoughts on building ETF portfolios is really a big treat for me.  

As you mentioned, one of my kind of number one themes with the portfolios that I build is simplicity.  

Today, with so much going on with regards to the Fed, with worries over inflation, with the trend of the US Dollar, and commodities, there’s so much worry out there about all these complicated interconnected systems within the market.

And, of course, with the advent of ETFs, there’s so many different vehicles that you can use to sort of move your portfolio around.  

You can hedge your currency exposure with different international ETFs, you can hedge your stock exposure with volatility or with short positions, you can take all sorts of leverage bets on commodities or other areas of the market.  

Really, what I’ve seen as I’ve reviewed investor’s portfolios more and more is that they’re using ETFs in their portfolio, but they’re using them in very complicated ways; adding in all sorts of kinds of different hedges, trying to time the market in different ways.  

It creates a very complicated picture in their portfolio and I really found that they’re not achieving the types of returns that they expect because it’s constantly chasing itself in a circle.  

When I think of simplicity, I think of the KISS principal; Keep It Simple, Stupid. And it’s just a much easier way to invest.  You want to own a small number of diversified funds that you understand, that are transparent, and that are low cost.  That’s the way I define simplicity and it’s sort of the hallmark of the bulletproof ETF portfolio.

Steve Halpern:  Now, a second leg to your triple-theme here is the importance of low cost when building an ETF portfolio.  Could you expand on that?

David Fabian:  Absolutely!  Well, as many people know, ETFs are one of the lowest cost investment vehicles possible and they’re continuing to see portfolio costs drive closer and closer to zero.  

When we look back sort of over the history of the market, mutual funds were really a game changer out there, but they’re still quite expensive; we still see mutual funds today charging 1%, 2%, some even as high as close to 3%.  

We see annuities out there extremely expensive.  We see whole life insurance and universal life products that are marketed as investment vehicles that are also extremely expensive.  

Costs have an extremely important drag on your portfolio over the long-term.  If you’re not able to compound your wealth -- the more money you give up in fees the less you’re able to compound over time -- so ETFs allow for a very efficient way for you to grow your wealth using a very low cost investment vehicle.  

Now there’s ETFs that charge as low as three or four basis points to own thousands of stocks over the course of a year.  That’s an extremely efficient way to get exposure to the market and that’s one of the reasons I love these investment vehicles.

Steve Halpern:  Finally, the third leg of this stool is asset allocation; I know you’ll be covering this area in depth in your workshop, but I was hoping you could give our listeners a quick overview of how you approach asset allocation in an ETF portfolio?

David Fabian:  Absolutely!  I think, again, it comes back to the KISS principal again of keeping things very simple.  Most people, all they really should be focused on is stocks, bonds, and cash.  

Now, again, some people are going to have a little bit of commodity exposure, some people are going to want to break down their stocks between international, domestic.

Those are all fine as well; you can certainly sort of shape your asset allocation according to your investment beliefs and things like that.

But at the end of the day let’s think about the easiest way to approach your portfolio or stocks, bonds, and cash and, sort of, when you’re planning out the asset allocation, you have to pay very close attention to how these individual sleeves of your portfolio are constructed.   

We can talk about asset allocation is a very important function of risk management.  One of the things I see too often is people put too much of their portfolio in stocks or too much in bonds and they get caught in too much of a risky situation at the tail end of a market cycle.

Instead of relying on stop losses, instead of relying on other things in your portfolio, a risk management plan really starts at the outset with not taking too much risk to begin with, so paying very close attention to your asset allocation is going to be a huge driver of your returns.

If you’re a more conservative investor, have a lower allocation of stocks; there’s nothing that says you have to be a 60/40 investor in stocks and bonds.  

You could have 40% in your portfolio in stocks, you could have 30% in stocks; whatever you’re comfortable with your risk tolerance, that’s how you should be constructing your portfolio overall.

And there’s so many different ways that we can do that and I’m going to be diving into more of those during our presentation at The Las Vegas Money Show.

Steve Halpern:  Let’s look at a few of your core holdings and for exposure to stocks and, particularly, you like the Vanguard Total Stock Market ETF (VTI), as well as the iShares Core Total Market (ITOT). Could you walk us through an overview of these funds and why you find them attractive?

David Fabian:  Absolutely!  Those two funds are really what I consider core holdings for a traditional broad-based portfolio.  They’re simple, they’re low cost, and, in many cases, they can be transaction free when you’re buying and selling them at your brokerage company.  

If your money is at Vanguard or if your money is at TD Ameritrade, you can buy VTI commission free, you can also sell it commission free, according to their rules.  

If your money’s at Fidelity, you can buy ITOT commission free there, so really these provide very simple, good building blocks for the stock allocation of your portfolio.  

Both funds own thousands of stocks in the market.  They’re essentially meant to be a representation of the total market, so large-cap stocks, mid-cap stocks, small-cap stocks; you basically own everything out there in a very diversified investment vehicle, a vehicle that’s also very liquid as well.  

There’s billions of dollars in these ETFs and they’re bought and sold, they trade hundreds of thousands of shares a day, so it’s very easy to get in and out.

If you’re able to have something like this where you own virtually every stock in the market it’s really a perfect building block for the stock allocation of your portfolio.

And then you can go on and customize your exposure after that using a strategy like low volatility or dividend stocks or something along those lines, but starting off with a very broad asset allocation like VTI or ITOT is a perfect way to get exposure to the market in a very low cost vehicle.

Steve Halpern:  Now, turning to the bond side of the equation; among your core holdings, you like the iShares Core US Bond Fund (AGG), as well as the Vanguard Total Bond Market ETF (BND).  Could you walk us through an overview of these holdings?

David Fabian:  Absolutely!  Really, for people that are sort of transitioning their portfolio away from mutual funds or away from annuities; funds like BND and AGG are excellent ways to get exposure to fixed income in your portfolio.  

It’s a similar concept as the last two ETFs that I talked about.  They’re very low cost, they’re extremely liquid, and they’re highly diversified.  

Both funds own thousands of bonds across the US fixed income market, so investment grade corporates, treasuries, mortgage bonds, high-yield bonds; they own a little bit of everything out there.

So it’s a very diversified way to build the basis of the fixed income allocation within your ETF portfolio.  

Again, then you can spice in some different ETFs as well; if you are concerned about rising interest rates you can buy a different type of bond fund with a lower exposure to duration; if you want some exposure to investment grade bond funds, there’s ETFs that fall along those lines, as well.  

Starting out with some of these core funds allows you to build on some other tactical positions as well and with five to 10 ETFs, you can really cover a very nice swath of the investment market for a very low fee.

Steve Halpern:  Finally, I know now that in recent issues of the Flexible Growth and Income Report you’ve spoken favorably about Jeffrey Gundlach and one of the funds that you’ve discussed is the SPDR DoubleLine Total Return Tactical (TOTL).  What’s the attraction here?

David Fabian:  Yeah, I just recently wrote a very detailed article on TOTL on our blog at, but essentially, this fund; we actually own this for clients of our firm.  

It’s been a very solid position and really it’s a way, as I’ve kind of mentioned, if AGG is sort of the broad-based passively-managed index that you’re going to build your fixed income exposure on, TOTL is sort of the actively-managed equivalent of that.  

It’s got a little bit different underlying components in it; it has more mortgage bonds, it has some emerging market bonds, it has some bank loans, and it’s going to have less exposure to treasuries and investment grade corporate debt.  

One of the advantages of TOTL is that it’s got a much lower duration than the index and it’s got a much higher yield as well, so you can kind of use sort of an actively-managed bond fund like TOTL or also another fund I like is the PIMCO Total Return Bond ETF (BOND).

These are managed by very well-known fund managers in DoubleLine and PIMCO that have decades of experience in the fixed income markets.  

I really like to pair sort of that active and passive management together because I think you can get a little bit more differentiated exposure in the active managers that add value over time.  

They really do a lot to manage the risk in the portfolio with regards to interest rate risk and the like; they can also add some additional yield to the portfolio as well, so that’s some of the reasons I really like those types of funds.

Steve Halpern:  Again, our guest is David Fabian of FMD Capital.  Thank you so much for your time today.

David Fabian:  I appreciate it.  Thanks for having me, Steve.  Look forward to The MoneyShow as well.

By David Fabian, Money Manager at FMD Capital

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