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If you read my last post about why I'm not going to buy a retirement annuity, you will know that I recently decided to move the majority of our retirement savings into low cost index tracking ETFs. However, to keep the post focussed around why I was doing that I didn't go into detail about which ETFs I've gambled my future on. Well I know my readers and I also know they are devils about the detail so I thought it would make a lot of sense to do a post about the "Magnificent 7" as they will be affectionately known going forward.
I'm also going to try and explain my thought process and strategy. If you haven't read the previous post, don't worry, it's not a prerequisite, but you do need to know my logic to understand my point of view. That is simply that;
I'm 44 now, I plan to pop my clogs on my 100th birthday and I am not planning to buy an annuity with the retirement savings that Mrs H and I accrued before we emigrated to South Africa from the UK in 2014. This means they'll be invested for 11 years until we start slowly drawing down on them from age 55 and will be used up completely by the time I cash in my chips. The value of those savings today is around R7,500,000 / $440,000 / £350,000.
Ok, so now you're up to speed, let's get down to business. My Magnificent 7 ETFs (and allocation) are:
Vanguard S&P500 (VOO) - 45%
Vanguard Total Stock Market (VTI) - 12.5%
Vanguard Mega Cap Growth (MGK) - 12.5%
Franklin FTSE China (FLCH) - 7.5%
Vanguard Healthcare (VHT) - 7.5%
Vanguard FTSE Emerging Markets (VWO) - 7.5%
Vanguard Total International Stock (VXUS) - 7.5%
And there they are, aren't they pretty?
Ok, let's talk about why;
Let's start with the general strategy. Firstly, you'll notice there's a definite lean towards Vanguard, that is simply that they lead the market on low fees, they've been around for ages, and you can get a lot of historic detail about performance. Secondly, 77.5% of the investment is in broad well established indexes with 100's of companies in them, this is about reducing risk. Finally, the remaining 22.5% is in slightly higher risk but adds a little diversity and targets a couple of markets I think are going to be hot in the next few years (China, Healthcare & Emerging markets). My strategy is to pretty much never change the 77.5% unless it's simply to move to another fund tracking the same index for a lower fee. The 22.5% will change as and when an obvious opportunity arises or if one does not exist, will also be added to the "Safety Zone" in the 77.5%.
Ok, so that's the basic idea. Let's have a quick look at each fund individually
1. VOO - Vanguard S&P 500 Index Tracker - 45% Allocation
This is a personal favourite and I've been invested in this fund at different times and amounts for a few years now. It simply tries to mirror the performance of the S&P 500 index which is the biggest 500 companies in the US. Whilst this is essentially an american fund, it covers most of the global players that we all know and love like Apple, Visa, Facebook and Disney to name a few. Wherever you're sitting right now, most of the branded products you can see are probably linked to the S&P 500 somehow.
The fund has super low fees of 0.03% which for my investment of around R3,375,000 / £200,000 / £150,000 is just R1,000 / $60 / £47 per year, that feels like a bargain to me.
In terms of performance, this fund has delivered an average annual return of 14% since its inception in 2010. Over 10 years, it's delivered:
1 Year - 15.0%
3 year - 12.2%
5 year - 14.1%
10 Years - 13.7%
People love quoting Warren Buffett (One of the richest men in the world) and I might as well jump on the bandwagon. Warren has advised that after his death 90% of his wealth is invested into a low cost S&P 500 index tracker.
If it's good enough for Waz, it's good enough for me!
2. VTI - Vanguard Total Stock Market Index Tracker - 12.5% Allocation
This fund is not dissimilar to the S&P 500 ETF above except it's not the top 500, it's all US listed companies. The only limitation with the S&P500 is you might miss out getting into a new invention before it explodes. As this fund includes small and startup listed companies (known as Small Caps) you're going to own the next Tesla or Netflix from day 1. When it eventually does explode and get into the S&P 500, I'll already have enjoyed it's growth. However, it does also mean I'll own a bit of all the failing companies, so it sort of evens things out a little. The big advantage here is that your money is spread over more than 3500 companies so your risk of total loss is pretty low unless the good ol' US of A simply ceases to exist, at which time I'll have more to worry about than my pension investments!
This stock is essentially a bet on the US as a country. While it may be having a few crazy moments right now with COVID and the presidential elections, over the long term I'm pretty sure it will continue to be a superpower and will churn out some amazing companies. The fees on this fund are also just 0.03% so another tiny cost for a great fund.
In terms of performance; since inception in 2001 it has delivered a 7.6% return. But wait? I hear you cry, that's less than my target of 9.5%. You're right, however, don't forget the financial crisis in 2008 is built into that time period. If you look at the last 10 years, you get a much better picture:
1 Year - 15.0%
3 year - 11.7%
5 year - 13.7%
10 Years - 13.5%
yes there is probably going to be another financial crisis at some point but with a 54 year investment timeline, I'm pretty sure this fund will easily make 9.5% and in my opinion, nearer 11% over that time.
3. MGK - Vanguard Mega Cap Growth - 12.5% Allocation
This fund is where we start to dial up the risk a little in order to generate slightly higher returns. This index is made up of just 100 companies but as the title suggests, these are the behemoths of US companies like Microsoft, Amazon and Google. They are the top 100 of the S&P 500 so I effectively own them now in all three funds we've reviewed so far.
Of the 100 companies in this fund, they have an average value of R6.8 Trillion / $400 Billion / £316 Billion each (There was just too many noughts to write the whole thing out!). To put that in perspective, the S&P 500 companies have an average value of R2.46 Trillion / $149 Billion / £114 Billion so we're taking about the titans of industry. Owning the biggest companies in the world is a little bit more expensive though at 0.07%, but I think it's well worth it considering the amount of money they're making.
In terms of performance this fund has returned a steady 12.41% since its inception in 2007. bearing in mind that was right at the point of the financial crisis, it makes a bit more sense why I would take on a little bit more risk for his fund when you look over the last 10 years:
1 Year - 41.5%
3 year - 22.2%
5 year - 20.4%
10 Years - 17.35%
Get a look at that!
I'm sure I shouldn't expect the eye watering performance of the last year again but even if you take the 10 year average, that's almost double the amount I need to retire comfortably. The obvious question for the layman would be; "Why don't you just invest the whole pot here?" the answer is risk. As we're just on our FIRE number, I can't afford a sudden or unexpected loss for any length of time. However, over the next few years, if things go better than plan (e.g. more than 9.5% annual returns) I plan to move any surplus created by over-performance into this fund and try and increase the allocation over time.
4. FLCH - Franklin FTSE China - 7.5% Allocation
So this is where things start to get a little more spicy!
You will notice that this is my only non-Vanguard fund. Why? Because whilst Vanguard do a China Stock Market Index Tracker, they charge 0.4% fees for it and it only opened in 2018 so has very little historical info. Conversely Franklin Templeton have an ETF that is a year older and costs half as much at 0.19% fees.
This is where index investing starts to make sense as theoretically both the Franklin and Vanguard funds should deliver the same performance over the long term so paying double the fees is therefore pointless. I am a loyal Boglehead (the term used for Vanguard fans, named after the founder of Vanguard and godfather of low cost index investing, John Bogle) but if Mcdonald's was selling a cheeseburger for $1 and Burger King were selling the same cheeseburger for $2, you know I'm going to go and see Ronald.
So why China? It's been really difficult to invest in China until recently and only a few ETFs exist. My rationale is simple, right now (and for the foreseeable future) China is the manufacturing capital of the world and in my opinion, nobody can knock them off that perch due to their cheap labour, strict ethic of efficiency in the workplace and their strong technological capability. That is a personal opinion rather than a fact based view. Let me explain my thoughts a little more simply. Amazon is the biggest company in the world right? right. What percentage of their products originate from China or use Chinese manufactured components, the majority right? right. Apple is the biggest Phone Company in the world right? right. Where do a large amount of their components originate from? China right? right.
Now at this point before I get verbally attacked in the comments, I understand that the explanation above would be more appropriate if I said Asia, rather than China to encapsulate other countries like Korea and Malaysia, and as a result I would be better buying a fund like the iShares Asia Top 50 ETF or something similar. That is true, but this investment is about putting a little bit of our savings into something speculative that might give better than average returns so choosing China was to make the investment to be a bit less broad, a bit higher risk and hopefully a bit higher returns over the long run.
So let's look at performance:
Since inception in 2017 has been just 6.56%. However, this has included a bit of a slowdown from China over that time period and my view is that China will recover from that. This theory is backed up by the 1 year performance which is a massive 34.29%.
The ultimate question will be if that recovery can continue and only time will tell. Either way, this is by far my riskiest pension investment and is as much a gamble as anything I've invested in. My thought process here is to hopefully see good returns in the short term and then keep taking the profits and re-allocating those profits into my safer funds like VOO, or VTI and slowly decrease the allocation percentage of this investment. Let's see if I'm right!
This is one of two ETFs on my list I have to monitor and make sure it stays in my comfort zone and meets my values. We've all heard allegations against companies like Apple of it's suppliers running sweatshops and stories of unsafe work practices in China. I'm relying on Franklin Templeton to ensure it's portfolio of companies don't fall into those categories. I will need to sell out of this ETF if I find any evidence that I'm supporting any kind of oppressive regime but I'm currently comfortable it's an investment into a developing nation.
5. VHT - Vanguard Health Care ETF - 7.5% Allocation
This investment is my attempt to leverage a global event which in this instance is COVID-19. As I type, the global pandemic has been going for close to a year and has no sign of abating before a vaccine is found. the daily infection rate keeps going up and is now as high as 490,000 new cases per day. 42 million people have caught the virus and only 31 million of those have recovered so far. 1.1 million people have tragically lost their lives and it's impossible to guess where that number will end up.
Despite being the biggest global event in my life time to date, it has resulted in a race to find a vaccine to end the pandemic and limit loss of life. However, it would also be naive to think that the company who creates the first vaccine will not become a pretty profitable organisation. Looking at the health sector more broadly, every government in the world is going to spend billions if not trillions in protecting its people and its economy through massive investment in healthcare over the next few years.
So now is not a bad time to get into the healthcare business and the easiest way to do that is through a health care ETF. The Vanguard Healthcare ETF is made up of 430 of the largest healthcare providers including Johnson & Johnson, Pfizer and Merck & co. If you've ever been sick or bought something at a chemist, you have almost certainly bought something manufactured by the companies in this ETF. Most importantly, one of that 430 is fairly likely to come up with the vaccine or at least be a licensee or distributor of it.
The fees on this ETF are 0.1% which despite being the most expensive Vanguard ETF so far, is an absolute bargain when compared to the average fees across all health care ETFs which is a massive 1.22%.
As you can imagine, this investment is not the kind of investment you look at past performance on, as it's almost all riding on the last 10 months and the next 2-3 years but when you look at the performance of this ETF before COVID-19 even existed, you can start to see why this has made my list.
Since inception in 2004, the Vanguard Healthcare ETF has delivered a 10.26% annual return, slightly ahead of my required number of 9.5% which is great.
Now if we look over the last year, you can see the effect that the coronavirus is having on the sector and precisely why I expect a good return over the next few years:
1 Year - 23.4%
3 year - 12.0%
5 year - 12.4%
10 Years - 15.9%
As you can see, things have definitely heated up this year so I hope to capitalize on all of that government investment in the short term and if I'm wrong, over the long term, 12% returns make a good backstop to reduce risk.
I have to admit doing a little soul searching on this one as it does have an air of "Ambulance Chasing" if you over analyse it, but having thought long and hard, I'm comfortable that this is not an unethical investment. I am investing in healthcare companies. They are trying to save lives and end this pandemic, the increased revenue is through an overload in work, not profiteering (I hope). It's akin to Amazon selling more stuff due to lockdowns or Zoom becoming massive because everyone started using video conferencing. If my view changes and it's clear the Healthcare industry is profiteering, I will sell this ETF without delay.
VWO - Vanguard FTSE Emerging Markets - 7.5%
This investment is the one I honestly have the least faith in. Why? I moved from an emerged market (UK) to an emerging market (South Africa) six years ago and the difference is stark. Government corruption, under investment in infrastructure, badly managed and failing state owned companies, junk status economy etc. etc. I could go on.
This is not a cheap shot at South Africa, I've made this my home, I love it here and I'm trying to add to the economy and support change, but if this is typical of most emerging markets, you need to consider what you're signing up for. South Africa is part of BRICS; Brazil, Russia, India, China And South Africa, which are deemed the main five emerging countries, although in my opinion, all have some fairly major issues that need to be dealt with.
However, I need a little diversity in our investments and there are some pretty massive companies on those emerging markets that whilst not as popular as the FAANG kids (Facebook, Amazon, Apple, Netflix & Google), they are quietly growing and are serious future contenders. You may not have heard of Alibaba, Tencent & Naspers but I can promise you they're big, they're really big.
Alibaba has revenue of $72 Billion this year, that's not so far away from Amazon's $100 Billion. Tencent owns loads of companies, one of which is WeChat which has had close to 900 million users, Facebook has 2.7 Billion users. Naspers is a South African company who coincidentally owns a massive chunk of Tencent it grew so big over the last few years that the company had to be split to list on the Johannesburg Stock Exchange and the Amsterdam Stock Exchange as it was making up a large percentage of the total South African stock market.
So whilst I tended to think that emerging markets means investing in small or struggling countries, it's actually also giving you access to some companies who could grow into the next mega caps and exist outside of the US and as such don't feature in my other investments.
All that said, there is no denying emerging market investments are volatile and risky, however, they seem to thrive when the market leading economies are flagging so I consider this investment a little bit of a hedge on my heavily US biased portfolio. It also covers over 5000 companies so it is super broad which despite short term volatility should mean over the long term it should deliver steady returns.
in terms of fees, the Vanguard emerging markets ETF comes in at 0.1% so still sits firmly in the low cost category. Performance since inception in 2005 comes in at a pretty measly 6.14% and it gets worse when you look at 10 years:
1 Year - 10.4%
3 year - 2.5%
5 year - 8.3%
10 Years - 2.3%
You're probably now wondering why this made the list. I'm also wondering the same thing given those numbers!
My observation is that emerging markets are cyclical and things are at a bit of a low right now in my opinion. I think over a 3 to 5 year period we'll see an upswing post COVID-19 and then like my China investment will be time to take profits and re-invest in the S&P 500 ETFs.
Once again, time will tell.
7. VXUS - Vanguard Total International Stock - 7.5%
Finally at number 7 of 7 is Vanguard's Total International Stock ETF. This fund covers over 7500 global companies but excludes any in the US. It should be pretty obvious why I invested in this stock, it reduces my bias to the US and S&P 500 a little and makes sure I have every last base covered. This gets me a chunk of Europe, The Pacific and actually a little more emerging markets. the average size of the companies in this fund is $27 Billion so it's globally the big boys. This gets me a little chunk of companies like Samsung, Toyota and Unilever which I wouldn't get in my other investments. It's a super broad index so it's not going to give any massive returns outside of the average stock market returns and is definitely one of my "Buy and forget" investments. The strategy for holding this ETF is that if you pair this with S&P 500 (VOO) or Total Stock Market (VTI) you get a clever little 2 fund portfolio which you can tweak to balance your risk and returns.
Fees come in at just 0.08% so good value but it's certainly not going to win any competitions for performance with just 3.43% annual returns since inception in 2011. because of its newness, it doesn't have a 10 year view but the 5 year looks like this:
1 Year - 3.7%
3 year - 1.3%
5 year - 6.3%
Another one which would have you ask "Why?" and it would be a fair question. This fund has struggled for the last 3 years and the COVID crash hurt it badly and it still hasn't recovered. This has me thinking that I might be getting in on this fund relatively cheaply. Let's look at it simply; it is made up of the biggest companies in the world outside the US but including Europe, Asia and the Middle East. Europe is the second biggest developed continent in the world, the middle east has most of the oil which although dwindling, still powers a large chunk of the global economy and as discussed earlier Asia is the manufacturing hub of the world. This fund only contains the big companies from those regions.
So why is it not delivering good returns? I don't know! That's why I'm investing because it should be.
This is a long term play with a small percentage of my portfolio and my gut tells me that whilst I would never bet against the US, they are not the only country in the world who has ideas and inventions and great minds. The world is changing, location is becoming less important, as is language. I do believe we're becoming a global village and if I'm right, this investment will thrive in that environment.
If I'm wrong, and here's the kicker, it means my other investments in the US (that are much bigger) are going to do great, so it's kind of a win win, no? I'll submit that that is some twisted logic right there but you can't argue with the fact this investment is the direct opposite of 70% of the rest of my portfolio so if it goes badly, It will automatically be compensated.
And that's it!
Officially my longest post ever so thanks for sticking at it if you read this far. Hopefully at this point you see some logic in my portfolio and hopefully you agree that it will boost my returns from the safe 8% I was getting up to a much more lifestyle increasing 12% over the rest of my lifetime.
Hopefully it's been of interest, and if it has and you haven't already, please subscribe. Next time, we'll be discussing the very controversial subject in the FIRE community; Financial Advisers. More specifically; if you need one.
Light the blue touch paper and stand well back people!
Until then, keep living.