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Even in a bear market, Vanguard Total World Stock ETF (NYSEARCA:VT) is one of the best ETFs you can buy for the long term. Investors looking for a less aggravated haven from current market conditions may want to think about this fund.

Diworseification is not so bad

One of the main criticisms of VT is that it diversifies into underperforming markets, which reduces the fund’s total return. Yes, and this is by design.

VT is an ETF that seeks exposure to companies across all market sectors, geographies and currencies. With exposure to over 9,500 stocks in free float-adjusted market capitalization weighted proportions, it owns nearly every publicly traded stock in the world. For the month ending March 2022, its top 10 holdings shown in the table below accounted for nearly 16% of the fund. For a fund that holds shares in almost every company in the world, it is oddly focused on the US market. Indeed, US equities make up nearly 60% of this fund’s assets.

VT's top 10 equity holdings make up a small portion of its portfolio.

VT’s top 10 equity holdings make up a small portion of its portfolio. (Avant-garde)

From a diversification standpoint, this is the most stock diversification you could ask for. The Vanguard 500 Index Fund ETF (VOO), for example, has its top 10 holdings making up 30% of the fund. By holding market capitalization weightings of virtually every company on Earth, VT becomes the Vanguard ETF that strives hardest to achieve the highest possible risk-adjusted return for its shareholders. These companies are even suitably spread across all sectors, as shown in the figure below.

VT's sector exposure is well diversified.

VT’s sector exposure is well diversified. (ETF.com)

In the short term, however, the diversification’s implicit promise of impeccable risk-adjusted returns may not be fulfilled. In the figure below, VOO, in blue, outperformed VT, in yellow, by almost 4% annualized with a slightly lower standard deviation. This is largely due to the poor performance of international equities, as approximated by the Vanguard Total International Stock Index Fund ETF (VXUS). Investors who were long in US stocks have doubled their money since the COVID-19 flash crash, but the same cannot be said for investors in the global stock market. Still, there are two things worth considering.

VT has underperformed the S&P 500 for the past 10 years.

VT has underperformed the S&P 500 for the past 10 years. (Portfolio Visualizer)

The first thing is that betting on VT means you don’t have to bet on USA. There is some safety margin in doing so, as it protects you in case the US significantly underperforms the global market. There are arguments that US markets will always be the most prosperous, but those arguments may not materialize. In fact, the US market has never generated the greatest returns; that honor belongs to the Australian market. American markets were not even always the largest in the world. Countries take turns dominating global market capitalization, and there’s no telling that the United States won’t eventually be replaced by another nation. You might argue that the United States will continue to outperform over your investment horizon, but you might also argue that it’s not worth taking that bet with your financial future.

The second thing is that for everyone long in the US market, there is someone short in the US market. For everyone who has made a fortune betting on the S&P 500, there is someone who has lost a fortune betting against the S&P 500. Foreign company stocks don’t disappear when apparently no one is interested. Someone has to hold the bag. Everyone has to own everything, so everyone owns the market wallet – the global market wallet. This means that the world will, on average, match the returns of VT. This puts you at the 50th percentile of returns before fees, which isn’t too bad. After the fees, however, it ends up doing you a bit above average; the only fee you pay is $7/year on $10,000 invested. If the markets continue to be as efficient as they are, your outperformance is very likely. Nearly 80% of fund managers failed to beat the market last year after fees were deducted, but that wouldn’t have happened to you.

Create a two-fund portfolio with VT

I don’t consider VT as a single fund portfolio as a target date fund because concentrating your entire portfolio in one asset class is inherently dangerous. Individual is the investor who uses the safest stock market ETF to pursue the riskiest investment strategy without leverage – even the leveraged crowd benefits from risk parity. 100% VT is dangerous for the same reason that 100% equity portfolios in general are dangerous; VT is subject to severe declines that can take years to recover. Certainly, through VT you are already exposed to stock markets that have not recovered since 2008, or even earlier, since the 1990s.

I would pair VT with a long-term bond fund like the Vanguard Long-Term Treasury Index Fund (VUSTX) to reduce volatility. In this article, I wrote about how long-term treasury bills complement stock index funds to minimize drawdown and standard deviation of return while increasing risk-adjusted returns better than any other class of assets. Below is a graph of 60% “VT” and 40% VUSTX and 100% “VT”. In this case, “VT” is simulated by 50% VTSMX and 50% VGTSX, which is a good approximation of the actual VT since inception.

Combining VT with bonds can improve risk-adjusted returns compared to a 100% equity portfolio.

Combining VT with bonds can improve risk-adjusted returns compared to a 100% equity portfolio. (Portfolio Visualizer)

Consistent with modern portfolio theory, a balanced stock-bond allocation can significantly reduce an investor’s volatility while capturing the majority of the upside. In this case, the maximum drawdown is halved and the standard deviation is reduced by 40%. Due to the rebalancing, the equity-bond portfolio even outperformed the 100% equity portfolio.

This approach is based on Taylor Larimore’s three-fund portfolio, which includes a total US stock market index fund, a total international stock market index fund, and a total bond market index fund. However, Mr Larimore prefers 20% allocated to international equities, which invalidates VT as a simple investment. If you want global market cap weightings, you can pretty much reduce Mr. Larimore’s three funds to two funds using VT. Mr. Larimore also prefers a total bond market index and, in a recent maintenance, Dr. William Bernstein even suggested short-term Treasury bills. It seems no one can agree on that, so I stand by my opinion on the use of long-term Treasuries. As Marco Pierre White says, it’s your choice.

A few reasons why you might not want VT

I don’t own VT in my own portfolio, but I use a combination of other funds to approximate VT holdings. It’s a bit more labor intensive on my end, but it doesn’t affect my ability to stick to my investment plan. It’s nicer to put my money in two funds instead of one, and I feel like I’m doing something special. That being said, I would have no qualms about replacing my non-tilted stock holdings with VT, as it’s not materially different from what I do anyway.

Everyone has their own financial goals and VT’s stock holdings may not match everyone’s needs. If your home country is underrepresented in VT, you might see significant currency volatility. You may choose to skew your portfolio towards equity holdings from your home country, in which case VT becomes irrelevant. If you are a citizen of anywhere outside of the United States, you probably shouldn’t buy VT and instead look for equivalent tax-advantaged funds. For example, if you are an EU citizen, you might end up choosing the Vanguard FTSE All-World UCITS ETF (VWCE). Choose the ETF that gives you the best deal.

Buy VT today

As for whether the average retail investor should buy now, well, yes, absolutely. You’ll be there for the long game. If stocks keep falling, that’s too bad, but you’ll still do better with VT vs. 90% of active funds after 20 years. If the stock goes up, you’ll be glad you bought the drop. I expect the stocks to fall a bit more, but I’m not worried about finding the bottom. Most investors’ dollar cost is average in their portfolios anyway, so eventually market timing errors show up in the wash.

Finding Alpha’s Quant gives VT a buy rating of 3.65/5. It’s always nice when machine learning algorithms agree with an investor’s intuition. Right now, the P/E ratio is hovering around the historical average, so we should expect average returns going forward. It’s around an 8% annualized.

In the end, there are far worse strategies than investing in capitalism. While investing in VT won’t make you a billionaire, its returns will likely be enough if you have some spare time.

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