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Fund Spy

The Four Passive Funds in My Portfolio

What I own and why.

I’ve long argued that most investors should own actively and passively managed funds. Both have merits, and you can apply many of the same criteria in choosing them. Either way, you want low costs, a good strategy, and good stewardship.

So, it probably won’t surprise you that I own four passively managed funds. They help to lower the costs of my portfolio overall, provide diversification, and serve as low-maintenance vehicles that I don’t have to worry over. My passive funds were the best available at the time, though there are some very good substitutes available now. I bought the Vanguard fund in 2006, two from Fidelity in 2009, and the DFA fund in 2014 when it was added to Morningstar's 401(k). 

 Vanguard Tax-Managed Capital Appreciation (VTCLX) is a good choice for your taxable account. Maybe I’m just a belt-and-suspenders guy, but I appreciate Vanguard’s effort to make index investing even more tax-efficient. This fund starts with the Russell 1000 Index and then makes tweaks to improve tax efficiency. It realizes losses to offset gains, and it tilts slightly away from dividend-paying stocks in order to avoid the dividends tax. It’s done a fine job on both fronts, producing aftertax returns in the top decile of large-blend funds.

 Fidelity Spartan Total Market Index (FSTVX) is one heck of a fund, costing just 0.05% a year. Total market funds are slightly more appealing than S&P 500 funds for two reasons. First, they cover the whole market. Second, they don’t have the awkward rebalancing process associated with the S&P 500, which can lead to stocks jumping into the index at a high weighting in such a way that arbitragers can take some money out of the pockets of index investors. For example, big stocks like  Yahoo (YHOO) entered the index at a high weighting, and because everyone knew they were going in, savvy market players could bid up the prices before index funds bought in. I don’t own  Vanguard Total Stock Market Index (VTSAX), but it is just as good. It has the same minimum investment of $10,000 and the same expense ratio of 0.05%.

All of that logic applies overseas, even though some people are wary of indexing overseas.

My next-largest passive investment is  Fidelity Spartan International Index (FSIVX), which charges 0.12%. The fund has outperformed its peers over the past three-, five-, and 10-year periods, so I wouldn’t say overseas indexing is all that bad.

If you want to avoid emerging markets, then the exchange-traded fund  Vanguard FTSE Developed Markets ETF (VEA) is a good alternative for 0.09%. In open-end form, the fund is  Vanguard Developed Markets Index (VTMGX), which charges 0.09% for a $10,000 minimum. If you want emerging markets folded into a foreign fund,  Vanguard Total International Stock Index (VTIAX) charges 0.14% for a $10,000 investment and 0.22% for a $3,000 minimum.

Finally, we come to  DFA International Small Company (DFISX), which is a much smaller position for me. Foreign small caps are useful diversifiers, but most people wouldn’t make them a big weighting. DFA is quite good at navigating small-cap markets in a way that limits trading costs. For small-cap indexes, trading costs are a huge hurdle: Bid-ask spreads can be wide, and index funds tend to trade in small amounts so they don’t get a good deal on share prices. DFA takes a more opportunistic approach by making bulk purchases of a variety of small caps that will help it track the small-cap market. DFA doesn’t strictly follow an index but makes sure that its portfolio behaves very much like a small-cap index.

The fund charges 0.53%, which is cheap for a foreign small-cap fund but not so cheap for an index fund. You may prefer to go with  Vanguard FTSE All-World ex-US Small-Cap Index (VFSVX). This fund charges 0.37% for those investing at least $3,000. The five-year-old fund figures to give the DFA fund a run for its money, although so far it has lagged the DFA fund a bit.

Premium Members can see all of our Morningstar Medalist index funds on the Morningstar Medalists page. (Select Index in the gray section on the left.)

Russel Kinnel has a position in the following securities mentioned above: DFISX, VTCLX. Find out about Morningstar’s editorial policies.