Just-the-Basics FAQ
WHAT IS THE SMI JUST-THE-BASICS STRATEGY?
Just-the-Basics (JtB) is the epitome of simplicity and low maintenance. It is a simple diversification strategy that uses just four Vanguard index funds. Sometimes simplicity pays off — SMI's 100% stock JtB portfolio takes just an hour or two per year to update yet has outpaced the market over the past decade. For an overview of how this strategy works, visit the Just-the-Basics page in the Visitors section of our website.
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WHY DOESN'T JtB BEAT THE MARKET BY A WIDER MARGIN?
Because it's not really designed to beat the market — it's designed to match the market. In JtB, you stop trying to beat the market, and in exchange you get the freedom of not having to do anything with your investments for a whole year at a time. The strategy runs on autopilot. If you want to beat the market, you'll need to get more actively involved, by either adopting the Enhanced Just-the-Basics variation of Just-the-Basics, or by switching entirely to the actively-managed Fund Upgrading strategy SMI offers. Neither requires much additional time, but it is important you be at least willing to check your investments monthly or quarterly with these other strategies. JtB is the only strategy SMI offers that you can set up and then forget about for an extended period of time.
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CAN'T I BUY AND HOLD A DIVERSIFIED PORTFOLIO OF ACTIVELY-MANAGED FUNDS AND GET BETTER RESULTS?
You can certainly buy and hold a diversified portfolio of actively-managed funds, but that probably won't help you beat the market, and is likely a recipe for lagging it. The reason is that in any given year, roughly 75% of all actively-managed funds underperform the market. Those numbers get even worse over longer time periods. Selecting individual funds that will beat the market over time is incredibly difficult. Rather than attempt that low probability game, many people prefer to take the market's returns via index funds, rather than suffer a below-market return, which is what most actively-managed funds produce. If you want to try to beat the market, you need to look into a more active strategy than simply buying funds and holding them for a long period of time. SMI's Enhanced Just-the-Basics and Upgrading strategies are two approaches that offer promising odds of coming out ahead of the market, but they require more time and attention than does JtB.
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WHY DOES JtB USE VANGUARD INTERNATIONAL GROWTH RATHER THAN INTERNATIONAL STOCK INDEX?
Vanguard Total International Stock Index is a "fund of funds," splitting its assets among three other international Vanguard index funds (European, Pacific, and Emerging Markets). Four of the five years this index fund has been open, it has trailed the returns of the International Growth fund. The explanation is the flexibility Int'l Growth enjoys to invest in the regions the manager finds most attractive, rather than being locked into a fixed regional mix. Until the index can demonstrate that its approach is preferable, we'll continue to stick with Int'l Growth.
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WHY NOT USE VANGUARD TOTAL STOCK MARKET INSTEAD OF HAVING TO BUY BOTH THE S&P 500 AND EXTENDED MARKET INDEX FUNDS?
The reason is that the Total Stock Market Fund tracks the performance of the Wilshire 5000, which is typically weighted in such a way that the S&P 500 stocks represent a little more than 70% of the fund, and the remaining Wilshire 4,500 stocks count for slightly less than 30%. If you put, say, $10,000 into the Total Stock portfolio, it would be like investing $7,000 in the S&P 500 and $3,000 in the Wilshire 4500. However, the JtB formula calls for having equal amounts in each, meaning you would be underrepresented in the smaller companies by using Total Stock Market. There are times like the late 1990s when the emphasis on large companies has paid off. But there are also times, like the last three years, when small companies have outperformed large ones, and JtB would have the edge. It's your call which allocation you prefer.
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CAN I SIMPLIFY JtB BY BUYING A VANGUARD LIFESTRATEGY FUND INSTEAD?
JtB was introduced to SMI readers way back in May 1992. A few years later, Vanguard introduced new "LifeStrategy" portfolios that embodied the simplicity of JtB. There are four LifeStrategy portfolios, labeled Growth, Moderate Growth, Conservative Growth, and Income. While the exact composition of each fund varies somewhat, it's reasonable to think of these as being roughly equivalent to JtB portfolios allocated 80%/20% stock/bond, 60/40, 40/60, and 20/80, respectively.
The LifeStrategy portfolios have now been around for over eight years, and we have enough performance history on the books to say they've done their job quite well. Their performance has been quite similar to their JtB counterparts. In fact, more often than not, the LifeStrategy portfolios have managed to eke out a small margin of superiority. It's not hard to explain why: their allocation to small company stocks is only about one-sixth that of Just-the-Basics. Small-cap stocks trailed the large company stocks found in the S&P 500 by roughly 3% per year during the eight years being examined. Historically, large-cap stocks and small-cap stocks have taken turns leading the performance derby, depending on where we are in the business cycle. As the economy has begun to emerge from the recent recession, small cap stocks have once again taken the lead and JtB has had the performance edge those years as a result.
The LifeStrategy portfolios are an attractive, easier-to-administer alternative to JtB for those with the portfolio allocations mentioned above. There is no LifeStrategy portfolio that is 100% invested in stocks, so investors using that mix should stay in Just-the-Basics. Vanguard investors using SMI's indexing recommendations can simplify their paperwork by switching into the LifeStrategy portfolio that uses the portfolio allocation they desire. Just recognize that you're making a major shift away from small cap stocks if you do this.
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DOES IT MATTER WHERE I OPEN MY ACCOUNT, SINCE INDEX FUNDS ARE PRETTY SIMILAR?
It's true that most index funds are going to earn similar returns. But in indexing, costs are incredibly important, as there isn't much else to distinguish one index fund from another. And on the subject of costs, Vanguard is usually the leader. For that reason, if you're setting up a new JtB account, Vanguard is probably the top choice. If you already have an account elsewhere, check the last few year's performance numbers of the comparable index funds at your brokerage vs. those of the Vanguard indexes. Calculate what the difference in returns actually means to your account balance, and if it's significant, you may want to consider moving your account.
A few years ago, SMI analyzed the difference between a JtB account at Vanguard vs. one using the NTF alternatives at Schwab over the 1994-1999 time period. Vanguard's large-cap index won out by 1.1% annually, and its small-cap index won by a whopping 5.7% annually, although in fairness, the two do track slightly different groups of stocks (similar enough for our purposes however). Schwab's foreign index won by 0.9% annually, but that still left a performance advantage of nearly 5.5% per year. While it's highly unlikely that broad an advantage will persist, it does point out that Vanguard's low-fee structure and indexing expertise does in fact make a difference.
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CAN I USE EXCHANGE TRADED FUNDS (ETF'S) RATHER THAN INDEX MUTUAL FUNDS?
Sure, but they may not give you as much of an advantage as you think. For one thing, any difference in expenses is likely to be miniscule, and only affect those with very large account balances. The ability to trade ETF's more easily is likely a non-factor, as JtB holds the index funds for the long term with hardly any trading. That basically leaves the negative of having to pay a trading commission to buy and sell the ETF, which would make them a net money loser for most JtB investors. However, since every investor's situation is different, if there's an advantage to using ETFs in your situation, feel free.
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DOES JtB OFFER ENOUGH DIVERSIFICATION FOR AN ENTIRE PORTFOLIO, SINCE IT ONLY INVESTS IN FOUR FUNDS?
It may feel like four funds can't be enough to diversify your entire portfolio, but in reality, you can't get any more diversified than JtB. That's because by owning these index funds, you essentially own the entire market. There isn't anything else to diversify into, unless you're talking about entirely different asset classes, like real estate. JtB makes you an owner of the entire domestic stock market—large and small companies both—plus the foreign stock market and domestic bond market. That pretty well covers all the bases!
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WHY NOT INCLUDE REAL ESTATE AND EMERGING MARKETS?
It's true that some studies have indicated that over long time periods, return can be increased and volatility decreased by adding these kinds of investments. SMI doesn't include them primarily because they add complexity to what is intended to be a very simple investing strategy, and the hoped-for improvements seem relatively minor (often not evident at all over shorter time periods). In addition, these components can be very volatile on a year to year basis, which is exactly the type of behavior we don't want rattling investors in our "low maintenance" strategy.
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