Barefoot Investing: Choosing The Right Etf

Scott Pape, the Barefoot Investor, is a well-known finance expert in Australia, who has written several books on personal finance. Pape's investing philosophy revolves around keeping things simple and investing in low-cost, passively managed index funds or exchange-traded funds (ETFs). Pape's investment strategy is based on the idea that by investing in a diverse range of stocks through index funds or ETFs, investors can achieve better returns with lower fees and less time spent on active management. Pape has shared several Index Fund portfolios over the years, including the Breakfree Portfolio and the Idiot Grandson Portfolio. These portfolios typically consist of a combination of ETFs and LICs (Listed Investment Companies) with varying allocations to Australian, international, and US stocks. Pape's recommendations have evolved over time, and he has also shut down his paid newsletter, The Barefoot Blueprint, in 2019. While Pape's advice can be a good starting point, it is important for investors to do their own research and consider their personal circumstances before making any investment decisions.

The Barefoot Investor's ETF recommendations

The Barefoot Investor ETF Recommendations

The Barefoot Investor, Scott Pape, is a trusted finance expert in Australia who has written several personal finance books, including 'The Barefoot Investor' and 'The Barefoot Investor for Families'. Pape has also shared ETF recommendations through his former paid newsletter, the Barefoot Blueprint.

The Breakfree Portfolio

The Breakfree Portfolio is an ETF portfolio Pape shared with Barefoot Blueprint subscribers. It is designed to be easy to manage and includes the following ETFs:

• STW (Australian Large-caps): 35%
• VSO (Australian Small-caps): 15%
• IOO (Global Large-caps): 20%
• VAP (Australian Property): 20%
• VAF (Australian Fixed Interest): 10%

The Idiot Grandson Portfolio

The Idiot Grandson Portfolio is another ETF portfolio Pape shared before shutting down the Barefoot Blueprint. It is a permanent set-and-forget investment portfolio designed to provide a steady stream of income in the form of dividends. To create this portfolio, Pape analysed 201 ETFs and 114 LICs listed on the ASX and used a three-stage filtering process to narrow down the options to just 10 funds:

• AFI: Australian Foundation Investment Company (LIC)
• ARG: Argo Investments (LIC)
• AUI: Australian United Investment Company (LIC)
• DUI: Diversified United Investment Company (LIC)
• MLT: Milton Corporation (LIC)
• VAS: Vanguard Australian Share Fund (ETF)
• VTS: Vanguard US Total Market Shares Index (ETF)
• VEU: Vanguard All-World ex-US Shares Index (ETF)
• VGAD: Vanguard MSCI Index International Shares (Hedged) (ETF)
• VGS: Vanguard MSCI Index International Shares (ETF)

Pape recommends the following allocations for the Idiot Grandson Portfolio:

• Australian Stocks: 75%
• Global Stocks (excluding the US): 15%
• US Stocks: 10%

Other Recommendations

In addition to the Breakfree and Idiot Grandson Portfolios, Pape has also recommended the following ETFs and LICs:

• AFIC: Australian Foundation Investment Company
• A200: Betashares Australian Bluechip Stock Index Fund
• VTS: Vanguard US Total Stock Market Index Fund
• VEU: Vanguard World ex-US Total Stock Market Index Fund

Pape has also expressed his preference for passive index funds over actively managed funds. He believes that index funds are a simpler and more cost-effective way to invest for the everyday Australian.

The Breakfree Portfolio

• Australian Bluechip Shares: STW – 35%
• Australian Small companies: VSO – 15%
• Global Bluechip Shares: IOO – 20%
• Australian Property securities: VAP – 20%
• Australian Fixed interest: VAF – 10%

The first ETF in the Breakfree Portfolio is STW, which tracks the ASX200 index and provides exposure to the 200 largest, most liquid, publicly listed entities in the Australian equity market. Pape recommends a 35% allocation in STW to concentrate returns on blue-chip Aussie stocks, which pay good dividends.

The second ETF is VSO, which tracks the MSCI Australian Shares Small Cap Index and provides exposure to small companies listed on the ASX. Pape recommends a 15% allocation in VSO to diversify within the Australian share market sector, weighting the portfolio towards small-size companies that have been shown to provide higher risk but higher reward.

The third ETF is IOO, which tracks the Global S&P 100 index and provides exposure to some of the world's biggest companies like Microsoft, Apple, Amazon and Nestle. Pape recommends a 20% portfolio exposure to global blue-chip shares to spread investment risk outside of Australia.

The fourth ETF is VAP, which tracks the Standards and Poor's ASX 300 A-REIT index and provides exposure to the Australian property market. Pape recommends a 20% allocation to VAP to provide diversification into a non-correlated asset class.

The fifth and final ETF in the Breakfree Portfolio is VAF, which tracks the benchmark of the Bloomberg AusBond composite 0+ year index and seeks to reduce volatility in the portfolio. Pape suggests a 10% allocation to this ETF to reduce volatility.

While the Breakfree Portfolio is a simple and diversified option, some critics argue that it has too much exposure to Australian stocks, with over 50% of the portfolio allocated to Australian companies. Additionally, the overall management fees for the ETFs in this portfolio are considered high, and there may be lower-cost alternatives available.

The Idiot Grandson Portfolio

The Filtering Process

The Barefoot Investor analysed 201 ETFs and 114 LICs listed on the ASX to find the best investments to add to this index fund portfolio. He used a three-stage filtering process to reduce the 315 funds down to just 10 index funds for the Idiot Grandson Portfolio.

First Cut (Remove High Fees)

The first cut involved removing any funds that had a management fee of over 0.40% p.a. This quickly reduced the amount of LICs down from 114 to 10 and the number of ETFs from 201 to 60.

Second Cut (Remove Undesirables)

The second filter removed any funds that were "undesirable". This included:

• Small-cap Funds: any funds that were focused purely on small-caps, due to their higher than average volatility, were removed.
• Outliers: funds that specialised in specific areas or strategies were removed, as they weren't broad in nature. This included things like high-yield dividend harvester type funds, which don't have great total returns over the long run.
• Synthetic: any funds that involved using derivatives or were synthetic in nature were removed, this included any internally leveraged funds as well.
• Equal-weight Funds: all equal-weight index funds were removed, as they don't track a market as closely as a market-weighted fund.
• Industrial Funds: and finally any industrial funds were removed, as they generally aren't tracking a broad diversified index.

Third Cut (Management Style)

The third and final filtering process looked at the management styles of the remaining funds. The Barefoot Investor chose to focus on funds that were purely not for profit.

The final 10 funds remaining in the Idiot Grandson Portfolio are:

• AFI: Australian Foundation Investment Company (LIC)
• ARG: Argo Investments (LIC)
• AUI: Australian United Investment Company (LIC)
• DUI: Diversified United Investment Company (LIC)
• MLT: Milton Corporation (LIC)
• VAS: Vanguard Australian Share Fund (ETF)
• VTS: Vanguard US Total Market Shares Index (ETF)
• VEU: Vanguard All-World ex-US Shares Index (ETF)
• VGAD: Vanguard MSCI Index International Shares (Hedged) (ETF)
• VGS: Vanguard MSCI Index International Shares (ETF)

The allocations recommended are:

• 75% Australian Stocks (VAS)
• 15% Global Stocks excluding the US (VEU)
• 10% US Stocks (VTS)

Simplified Version of the Idiot Grandson Portfolio

There is a much simpler and optimal way of constructing the Barefoot Investor Index Fund Portfolio, by using just 2 ETFs: BetaShares A200 ETF at 25% allocation and the Vanguard International Shares Fund VGS at 75% allocation. This gives you decent diversification to Australian companies and their sweet franking credits, as well as exposure to the rest of the world, and there’s no overlap as VGS doesn’t include Australian holdings.

The pros and cons of investing in ETFs

Exchange-traded funds (ETFs) are a versatile investment vehicle that blends features from both mutual funds and individual stocks, making them popular among all types of investors. They are baskets of securities that trade on exchanges like stocks, allowing investors to buy or sell shares throughout the trading day at market-determined prices. Since their introduction in the 1990s, ETFs have changed the investing landscape, offering broad diversification, wide availability, and relatively low costs.

The Pros of Investing in ETFs:

• Lower Costs: ETFs typically have lower expense ratios than mutual funds because they do not carry a sales load and have lower administrative fees.
• High Liquidity: ETFs can be bought and sold easily during normal market exchange hours, providing investors with greater flexibility and control over their investment decisions.
• Transparency: ETFs are listed on major exchanges, making it easier for investors to understand the underlying assets and their performance.
• Tax Efficiency: ETFs are passively managed, realising fewer capital gains than actively managed funds, resulting in potential tax savings for investors.
• Diversity of Assets: ETFs provide exposure to a diverse range of markets, sectors, and investment strategies, including stocks, bonds, commodities, and currencies.
• Trading Flexibility: ETFs allow for various types of trades, including limit orders, stop-limit orders, options, and short selling, providing similar flexibility to trading individual stocks.
• Reduced Volatility: By holding multiple stocks in a specific market sector, ETFs reduce the risk of a significant decline due to issues with a single company.

The Cons of Investing in ETFs:

• Commissions and Trading Fees: Frequent trading of ETFs can result in higher commissions and other trading costs, eroding overall returns.
• Limited Diversification: Some ETFs, especially sector-specific or thematic funds, may lack broad diversification and concentrate on a narrow group of equities, increasing risk if that sector or theme performs poorly.
• Higher Management Fees for Active ETFs: Actively managed ETFs aim to outperform the market but often come with higher fees, which can offset returns over time, especially if the ETF underperforms.
• Limited Access to Private Investments: Due to their structure and low-cost nature, ETFs generally do not provide access to private securities, such as private equity or venture capital, limiting the potential for higher returns from alternative investments.
• May Not Beat Individual Stock Returns: While ETFs provide diversification, they may not always match the potentially higher returns of carefully selected individual stocks, especially if the investor has the time and expertise to manage their portfolio actively.
• Intraday Pricing Might Cause Unwise Trading: Intraday pricing fluctuations can induce longer-term investors to make unnecessary trades, potentially leading to emotional trading decisions.

How to invest in ETFs

An Exchange-Traded Fund (ETF) is a simple way to invest in a large collection of stocks. An ETF might have thousands of different individual stocks in it, but you only have to make one purchase to own a portion of all of them. This gives you the benefit of diversification. If you have 5 individual stocks in your stock portfolio and one of those goes down and fails, you can end up losing a lot of money. On the other hand, if you go and buy an entire index fund, then you have hundreds of different stocks and companies that contribute to your overall return. So even if one of those fails, it doesn't really matter because you have hundreds of others to boost you up.

The Barefoot Investor's Approach to ETFs

The Barefoot Investor, Scott Pape, is a fan of passive index funds and the benefits they bring. Pape used to run a paid newsletter called the Barefoot Blueprint, where he shared stock and ETF recommendations, including some Index Fund portfolios. Pape has constructed two Index Fund portfolios: the Breakfree Portfolio and the Idiot Grandson Portfolio.

The Breakfree Portfolio

The Breakfree Portfolio is a fairly simple portfolio that predominantly includes Vanguard ETFs:

• Australian Bluechip Shares: STW – 35%
• Australian Small companies: VSO – 15%
• Global Bluechip Shares: IOO – 20%
• Australian Property securities: VAP – 20%
• Australian Fixed interest: VAF – 10%

The Idiot Grandson Portfolio

The Idiot Grandson Portfolio is a permanent set-and-forget investment portfolio that will provide a steady stream of income in the form of dividends that can be passed down through the generations. Pape analysed 201 ETFs and 114 LICs listed on the ASX to find the best investments to add to this Index Fund portfolio. He used a three-stage filtering process to reduce the 315 funds down to just 10 Index Funds for the Idiot Grandson Portfolio:

• The first cut involved removing any funds that had a management fee of over 0.40% p.a.
• The second filter removed any funds that were "undesirable". This included small-cap funds, outliers, synthetic funds, equal-weight funds, and industrial funds.
• The third and final filter looked at the management styles of the remaining funds, with Pape choosing to focus on funds that were purely not for profit.

The Idiot Grandson Portfolio includes the following funds:

• AFI: Australian Foundation Investment Company (LIC)
• ARG: Argo Investments (LIC)
• AUI: Australian United Investment Company (LIC)
• DUI: Diversified United Investment Company (LIC)
• MLT: Milton Corporation (LIC)
• VAS: Vanguard Australian Share Fund (ETF) – 75%
• VTS: Vanguard US Total Market Shares Index (ETF) – 10%
• VEU: Vanguard All-World ex-US Shares Index (ETF) – 15%
• VGAD: Vanguard MSCI Index International Shares (Hedged) (ETF)
• VGS: Vanguard MSCI Index International Shares (ETF)

Other Considerations

It is important to note that Pape's portfolios have a heavy home bias. Pape estimates that the international component will grow in value faster than the Australian one, and that after a couple of decades, the Australian component will become about 60%. It is also worth noting that Pape's portfolios are designed to work off the high dividend rate in Australia to generate a living income.

Before investing, it is recommended that you sit down with an independent financial advisor to discuss your individual circumstances and goals.

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