(This post is part of a new series taking a closer look at some popular portfolio holdings.)

The Vanguard Total Stock Market Index Fund is one of the largest funds in the world, and definitely the largest index fund. For individual retail investors, it is available in mutual fund flavors (VTSMX, VTSAX) as well as ETF flavor (VTI). Across all shares classes, there is currently over $230 billion dollars of total assets invested in this fund – that’s nearly a quarter of a trillion dollars! If you own a Vanguard Target Retirement or LifeStrategy fund, you own this fund as well. So let’s try to understand what’s inside.

Despite the name, the Vanguard Total Stock Market Index fund only tries to represent all the stocks in the U.S. equity market, from big to small, from financial companies to shoe store chains. The fund is currently transitioning from tracking the MSCI US Broad Market Index to the CRSP US Total Market Index. These are both market-cap weighted indexes, which means that the amount of each stock held is directly proportional to the total market value of the company. In other words, if all Nike shares together are worth $50 billion while Skechers is worth $1 billion, then the index would hold 50 times more Nike than Skechers.

Market Capitalization Weighting

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Here is a check-in on the trailing 10-year total returns for the David Swensen model portfolio, courtesy of ETFPM.com. Last update was in 2011. As a reminder, here is the model portfolio asset allocation with representative ETFs:

30% Domestic US Equity (VTI)
15% Foreign Developed Equity (VEA)
10% Emerging Markets (VWO)
15% Real Estate (VNQ)
15% U.S. Treasury Bonds (IEF)
15% Inflation-Protected Securities (TIP)

The chart below shows the growth of $1,000 invested this way and rebalanced annually (eMAC), starting from January 2003 until the end of March 2013. eMAC stands for “efficent multi-asset class”.

Again, we see that this low-cost, diversified index fund portfolio (+169%) has done well over the last 10.3 years, besting the S&P 500 (+118%) handily as well as the Dow Jones Credit Suisse Hedge Fund Index (not shown anymore, but +95% roughly). We also see that a 30% Stock, 70% Long-term Treasury bond portfolio does pretty well, but I tend to dismiss that as rearview-mirror investing. Yes, looking backward it did well, but I doubt you could find any portfolio manager telling their clients to hold 30% Stocks and 70% Long-Term Treasuries as a long-term portfolio during the period between 2003-2007.

In many investing books such as David Swensen’s Unconventional Success or Bill Schultheis’ The Coffeehouse Investor, you may see model portfolios that include an allocation to smaller companies and/or real estate investment trusts (REITs). Historically, adding these less-correlated asset classes have improved a portfolio’s overall return while reducing volatility. Author and portfolio manager Rick Ferri proposes another lens from which to view why such additions add value in his Forbes article called The Total Economy Portfolio.

Briefly, Ferri points out that the number of publicly traded companies has fallen by over 50% in the last 16 years, and those public companies together earn only about half of the U.S. economy’s profits. What is missing, and what should we do to replace them?

The two main areas of the economy that are underrepresented on the stock market are small businesses and commercial real estate. That means increasing small company and real estate exposure in your portfolio should help you track the economy better. […] My “Economic Tilt Portfolio” is allocated 65% to the Wilshire 5000, 25% to the Russell 2000 small-cap value index and 10% to the Dow Jones U.S. Select Real Estate Investment Trust index.

The chart from the article below compares the total return of the Total US Stock Market (Wilshire 5000) vs. the Economic Tilt Portfolio:

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Fidelity recently announced new changes to their commission-free ETF list.

When Blackrock iShares introduced their 10 new Core ETFs, I wondered how they would market these ETFs. Well, that question was answered today with Fidelity and Blackrock announcing a “long-term strategic alliance”, otherwise known as Blackrock writes a big fat check to Fidelity:

For iShares ETFs, Fidelity receives compensation from the ETF sponsor and/or its affiliates in connection with an exclusive, long-term marketing program that includes promotion of iShares ETFs and inclusion of iShares funds in certain FBS platforms and investment programs.

The move definitely makes sense though, as Fidelity doesn’t have a broad line of in-house ETFs and iShares doesn’t have their own brokerage arm. In general, I think the move is a positive one for Fidelity customers as they now have exposure to a much wider range of low-cost index ETFs meant for long-term holding periods. There are now a total of 65 iShares ETFs where you can avoid the standard $7.95 trade commission. You could build a low-cost, diversified portfolio with just these ETFs, resulting in a weighted expense ratio of just 0.10%:

33% Core S&P Total U.S. Stock Market (ITOT)
33% Core MSCI Total International Stock (IXUS)
33% Core Total U.S. Bond Market (AGG)

However, a few big names were also removed from their commission free list – iShares MSCI EAFE (EFA), and iShares MSCI Emerging Markets (EEM), and most of their Russell Index-based ETFs. If you had a large position in one of these ETFs, now you’re either stuck paying the standard $7.95 commission or you’d have to replace them with their new “Core” versions and thus incur possible capital gains taxes. I’d certainly be annoyed. There will be a short grace period (details below).

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