VT - VT: The Little Article Of Common Sense Investing

2023-07-13 10:25:13 ET

Summary

• The "relentless rule of humble arithmetic" states that the return of the stock market must equal the return of all investors, making it difficult to consistently outperform the market.
• The Vanguard Total World Stock Index Fund ETF offers exposure to the entire world stock market, holding 9573 stocks with a low expense ratio of 0.07%.
• While it is not impossible to outperform the market, it is very difficult and requires a lot of research.

The "relentless rule of humble arithmetic" is a very simple rule that most investors tend to ignore. This rule is that the return of the stock market must be equal to the return of all investors. If someone gets more in return, someone else gets less. It's a zero-sum game. Some people will outperform, some will underperform, and some will match the market return. It is very hard to consistently outperform the market.

The late John Bogle, author of the famous book The Little Book of Common Sense Investing and founder of Vanguard, was a firm believer that investors should only own index funds. The market has changed a lot since his book first came out in 2007 and many people are questioning if index investing is still relevant. I believe it is.

Vanguard Total World Stock Index Fund ETF (VT) offers investors exposure to the entire world stock market. It holds 9573 stocks and has a low expense ratio of only 0.07%. Active investors have a very poor track record and have to be smarter than the market in order to be successful. A little humility can go a long way. And if you're going to make an index fund a part of your portfolio, I think that VT is the way to go. I rate VT a Buy.

A quick note

Before I start my analysis of VT, I want to make it clear that I am not saying it is impossible to outperform the market, especially considering that as an analyst, I recommend assets that I believe will beat the market. I am simply saying it is very hard. If you're reading articles on Seeking Alpha, you're doing your research and this drastically improves your chances of outperformance. I also don't think that taking a shot at outperformance is bad. But I believe that while you take your shot at it, it's wise to have a considerable holding in index funds, specifically .

I recommend VT as the main holding for the equity portion of your portfolio. Depending on your risk tolerance and where you are in your investing journey, you may be focused on things, such as income and low volatility rather than maximizing long-run total returns. VT should not replace these assets.

If you have consistently outperformed the market, I am by no means saying that it has been luck. As I will discuss, if you have done this, you have done something that most full-time fund managers can't even do and I tip my hat to you.

Holdings

VT seeks to track the performance of the entire world market. It does this by holding 9573 domestic and foreign stocks. VT's top 10 holdings make up about 13.5% of its AUM.

All of these holdings are recognizable. While 13.5% isn't a huge percentage of an ETF's holdings, considering that 9563 stocks only take up 86.5%, it is heavily skewed to the top. This is expected considering it's a market cap-weighted ETF. Many people say that index investing is no longer relevant now that the top holdings take up a large percentage of the holdings. But the most basic idea of index investing is that the market is priced by investors. Investors think that VT's top 10 holdings are priced fairly. If this is the case, there isn't a reason to worry.

While this ETF does offer global exposure, it is heavily skewed to the US. About 60% of VT's AUM lies in US companies.

Again, index investors shouldn't see this as an issue because investors as a whole have decided that this 60% is an accurate reflection of the percentage value of US versus global equities.

Actively managed funds failures

Actively managed fund investment has been on the rise . Most of these fund managers don't accept the "relentless rule of humble arithmetic". Usually, the goal of these funds is to outperform the market. At first glance, this doesn't seem too hard. If VT holds all stocks, the winners, the losers, and the average performers, just pick the winners and you're guaranteed to find alpha. Well, it turns out this is very hard to do. While it's not nearly as hard to outperform the market for a year or two, what about 20 years?

A recent study showed that less than 10% of actively managed funds have outperformed the market for over 20 years. The same study tried to find out if actively managed funds could consistently, year after year, produce higher-than-average returns. this study looked at all 2,132 U.S. actively managed funds, only excluding those that focus on narrow market segments or invest with borrowed money (leverage). S&P Dow Jones Indices analysts calculated the performance of all these funds from the last 5 years, June 2017 to June 2022. They broke it down by year, so for each fund, they knew what percentage it earned in 2017, 2018, 2019, and on. They then organized the funds into quartiles, the fourth quartile having the highest performers, and the first quartile having the lowest performers. Finally, they observe how many of the 2132 funds that were in the top quartile in 2017 stayed in the top quartile every year through 2022. Want to know how many were able to stay in the top 25% over five years? Keep in mind that these are often run by Ivy League-educated professionals who have tons of research tools and experience. Zero. Not a single one.

After this, the S&P Dow Jones Indices analysts decided to change the study and find out what percentage stayed in the top half. So instead of being in the top 25% throughout the five years, the fund only had to be in the top 50% in each of the five years. The results are not much better. Less than one percent was able to do this.

Let's relate this information back to VT. I don't believe actively managed funds are likely to outperform VT long-term (over 20 years) or short term (last 5 years). Someone who chooses to invest in actively managed funds instead of VT has to pay more for less return. The average expense ratio for actively managed funds is 0.5-1%, whereas VT's is only 0.07%. Considering all of the above information, there is no reason to pay more for underperformance when an investor can just buy VT and get superior results.

Individual investors

Maybe you don't invest in actively managed funds. Instead, you choose your own assets that you think will outperform the market. When you do this, you are not just saying you're smarter than the market, but that you're also smarter than all the professional fund managers. Again, I'm not saying there's anything wrong with it; I do it and so many others do too, but while you take your shot at outperformance, I think the backbone of your portfolio should be VT.

Why VT

Now that the foundation of my Buy thesis has been established, let's discuss why VT is better than other index funds. While John Bogle argues for investors to own just domestic stocks, most "Bolgleheads" (what the people who follow his investing philosophy call themselves) disagree with him. Again, going back to the "relentless rule of humble arithmetic", the market has priced not just domestic stocks, but also international ones, meaning that international stocks are also trading at a price that investors as a whole think is fair.

Adding international stocks to your portfolio just adds more diversification. The global diversification also makes VT less top-heavy compared to VOO (Vanguard's S&P 500 ETF) and VTI (Vanguard's total US market ETF). The image below shows a slightly different top 10 holdings percentage than the image from vanguard.com shown earlier because of when the data was updated.

As the image above shows, VT's top 10 holdings make up far less of the AUM than VOO's and VTI's top 10 holdings do. This makes VT more diverse and takes away some concentration risk. With VT, your portfolio is not so dependent on the performance of a small number of US tech stocks.

Risks

VT tracks the performance of a very volatile sector. If we submit to the "relentless rule of humble arithmetic", VT is always a Buy, but there are times when it's hard to own VT. The market goes through years of stagnation and has crashes. During times like this, it can be hard to not go chase higher returns by picking your own stocks or going to an actively managed fund. But remember the study mentioned above. You are unlikely to consistently pick winners. It's best you stay put in VT because if you went somewhere else, you will most likely underperform.

A way to get the best of both worlds

It's very enticing to want to pick your own stocks and try to outperform the market. As I've said multiple times, this isn't a bad thing. What I and many other investors would suggest is having two portfolios, one that has your index fund, and one that you "play around" in. This lets you satisfy your need to try to outperform while still submitting to the "relentless rule of humble arithmetic". How much you should have in each depends on your risk tolerance.

Conclusion

VT offers exposure to the world market. While there may be a recession on the horizon, economists have been wrong before and there is a real chance there won't be a recession. Accepting the "relentless rule of humble arithmetic" can help many investors generate a larger return than they have in the past. Looking at the failure of actively managed funds shows just how hard it is to beat the market. I rate VT a Buy.

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