I note that some of my fellow financial freedom bloggers hold only one ETF – like a ‘swiss army knife’ of investing – in their long-term portfolio. Having only one ETF definitely would have made it easier to monitor my portfolio and ‘report back’ to myself. I also wouldn’t be kicking myself every year that I didn’t buy more of the better performing funds compared to the pathetically performing ones in my portfolio… But is a portfolio of one ETF enough?
1 One global ETF could be good enough if you’re saving for 20 years +
I should specify that we’re not talking just any index fund here. We’re talking specifically about a well diversified global equity exchange traded fund (ETF), like the Satrix MSCI World or the Ashburton Global 1200. If you’ve chosen one of these for your long-term financial freedom savings pot, I have to congratulate you. Of the four asset classes (equity, property, bonds, and cash), you’ve chosen the one that’s proven to be the outperformer over periods of 20 years and longer.
With that badge also comes some risk, notably the market crashes equity is prone to. Add to that the currency risk because your global equity ETF is linked to a ‘hard’ world currency, most likely the dollar, which means your portfolio is vulnerable to spells of rand strength. Unless you plan to emigrate, the currency of your one-global-ETF portfolio is misaligned with the currency of your future expenses.
You would therefore need a strategy to exit this ETF on a piecemeal basis to make provision for your initial drawdowns in rand when one day you reach financial freedom (assuming most of your expenses will be in rand). For example, you could start ‘carving out’ small chunks of this ETF and putting it in a less volatile rand-based low-risk investment a year or two before you’ll need the money, provided the rand is not historically strong at that point in time. Just enough to live from in your first year of financial freedom. Alternatively, you could simply postpone your ‘early retirement’/first drawdown from your financial freedom portfolio until the rand and the global equity market are trading at more acceptable levels. The more flexible your drawdown dates are, the more risk you can take on.
2 One global ETF could be enough if you also have an aggressive risk profile
If you’re going to hold a portfolio of one global equity ETF, you need more than time; you also need a strong stomach to ride out the price volatility of this type of ETF. Even if you won’t need the money soon, watching your portfolio value drop by 30% or more is more than many investors can psychologically handle. That’s why any good adviser or robo-adviser for ETFs will ask you to first go through a risk profiling exercise before they recommend a fund to you. On a behavioural level, one global ETF will only work if you have an aggressive risk profile. Any other profile, and you’ll likely be switching into a less aggressive, more diversified and less volatile portfolio with the first market crash you live through.
3 One global ETF is fine if you don’t want the tax benefits of an RA
This is the main reason why I have more than only global equity in my portfolio. Anyone in the 31% marginal income tax bracket, or up, can do with the tax relief from their retirement fund contributions. In my case, I’m saving more than R36 000 per year (the current TFSA limit). I therefore need another product for my savings above R36 000 – one where my income and capital gains are also tax-free as long as I stay invested. A retirement fund is the perfect tax deferrer. And, because I live below my means, my income in financial freedom will be much less than what I’m earning now, probably placing me in the 26% income tax bracket one day when I start to draw from my retirement products. Even though I’ll be paying tax on those withdrawals one day, it’s worth the size of the relief now and the tax-free status of the money while it stays in the fund. Tax only becomes an issue once the money starts leaving the investment.
With retirement products come many rules. One of them is that you’re not allowed to invest 100% of your retirement money in equity – only 70%. And you can allocate only 30% (40% if you include your Africa allocation) to global assets. Some modern retirement annuities (RAs) allow you to choose an underlying ETF but by law you cannot pick only one global ETF for your RA. What ETF you choose outside of your retirement fund, though, is none of the regulator’s business.
Tax relief is not everyone’s priority. Maybe your tax rate is currently so low that you don’t feel the need for an RA or other retirement product. Or you are preparing for emigration and don’t want your retirement savings locked up in one country.
4 One global ETF could work if it covers many regions and sectors
It seems like a portfolio of one ETF is enough if: 1) you’re saving for the long-term and your drawdown dates are flexible; 2) you have an aggressive risk profile; 3) you’re not a fan of or not in need of an RA or other retirement product; and 4) your global ETF covers many regions and sectors. Examples of global equity ETFs that are restricted to only certain stock exchanges or niche countries include any ETF tracking the Nasdaq-100, S&P 500, the Africa exchange, only emerging markets, only Europe or only China, to name but a few. That won’t do on its own. If you’re going to choose only one ETF for your portfolio, make sure it’s truly diversified worldwide.
Article reposted with permission from Go Freedom.