I recently learned of two brand new ETFs (launched just last week) that purport to provide only price appreciation rather than interest income, despite being bond funds. The benefit of such would be that all of the return that shareholders receive would be capital gains — and thus potentially taxed at the favorable long-term capital gain tax rates, rather than being taxed as ordinary income.

• F/m Compoundr U.S. Aggregate Bond ETF (CPAG)
• F/m Compoundr High Yield Bond ETF (CPHY)

The strategy is very simple. Each of the funds is a “fund of funds.” But at most times, each fund will own only one or two underlying ETFs.

• The aggregate bond ETF (CPAG) expects to own only iShares Core US Aggregate Bond ETF (AGG).
• And the high-yield bond ETF (CPHY) expects to own iShares Broad USD High Yield Corp Bond ETF (USHY) and SPDR Portfolio High Yield Bond ETF (SPHY).

And, on the day before the ex-dividend date for the underlying fund, these new ETFs will swap that underlying fund for a substitute fund which 1) has broadly similar holdings and 2) which will not be paying a dividend on that day. And then on the following day, the new ETF swaps back to the “normal” underlying fund.

So in short the idea is to just own a boring/normal bond ETF in the category in question, and temporarily swap it out for some other boring/normal bond ETF at the appropriate time in order to avoid receiving any dividend distributions.

(Terminology note: the distributions from a bond fund are still known as “dividends,” but they’re taxed as interest when it’s ultimately interest income from the underlying bonds that is being distributed.)

So, in theory, investors would get approximately the same total return and risk characteristics as the underlying fund, but with better tax-efficiency.

So what’s the catch?

Costs

The first catch is a simple and obvious one: the new ETFs add a layer of expenses. CPAG will charge a management fee of 0.39%, and CPHY will charge a management fee of 0.49%. Those costs are in addition to the fees of the underlying ETFs.

So any tax-efficiency that you gain would have to overcome that additional cost every year. The higher that interest rates are and the higher your marginal tax rate, the more likely it is that that the tax savings would overcome the costs. The lower that interest rates are and the lower your marginal tax rate, the less likely it is that the tax savings would overcome the additional costs.

Tracking Error

The next potential concern is that, even ignoring the costs, the new ETFs might not achieve the same performance as their primary underlying holdings, due to the periodic swapping of those primary holdings for substitute funds. Nasdaq (which is operating the new indexes that these new funds will track) published a document showing the most likely substitute funds.

For instance, as substitutes for iShares Core US Aggregate Bond ETF (AGG), the best partners appear to be Hartford Core Bond ETF (HCRB) and Fidelity Total Bond ETF (FBND). Here’s a chart from testfol.io showing the performance of those three funds for as long as they’ve all been around:

They’re definitely very similar, but they’re not identical. Swapping one out for another for just a handful of days per year shouldn’t make a big difference. But it’s possible that it might.

What about IRC § 1258?

Another broad category of concerns can be described as, “are the tax code and Treasury department okay with this?” In other words, does the proposed strategy not run afoul of any rules?

My answer to that would be: not that I can think of, but it’s always possible I’m missing something.

Another fund company (Alpha Architect) has sought to achieve interest-to-capital-gains alchemy in another way with their Alpha Architect 1-3 Month Box ETF (BOXX). There’s an excellent article by Daniel Hemel that raises substantial doubt as to the validity of their strategy though.

But I don’t think the concerns raised in that article apply here. The code section in question (IRC § 1258) becomes an issue when “substantially all of the taxpayer’s expected return” is attributable to time value of money. With a box spread (the underlying investment strategy employed by BOXX), time value of money is the source of substantially all of the expected return. With an intermediate-term bond fund, there’s also interest rate risk at play.

But again, maybe there’s some other regulatory issue that I’m not thinking of.

Is This Really Necessary?

It often makes sense to try not to own bonds in a taxable accounts (i.e., own them in tax-deferred accounts instead, where you won’t have to pay tax on the interest every year anyway). If you don’t have to own bonds in a taxable account, then you definitely don’t need something like these new funds.

And if you do have to own bonds in a taxable account, you don’t have to own high-yield bonds or even a total-bond fund. Within the bond portion of a portfolio, we don’t have to diversify in the way that we do with the stock side of the portfolio. It’s not crazy for the fixed-income side of the portfolio to consist of nothing but Treasury bonds (i.e., omitting investment grade corporate bonds as well as high-yield corporate bonds). It’s perfectly fine to stick with something that’s reasonably tax-efficient to begin with, such as a short-term Treasury fund (or a tax-exempt bond fund, depending on your marginal tax rate and how municipal bond yields compare to yields on other bonds).

There’s always a risk to being a guinea pig. Personally, even if I were financially in the target market (i.e., needing to hold bonds in a taxable account), I would be inclined to take a “wait and watch” approach for at least a few years. I really don’t like my investments to be exciting. I’d wait until these are old and boring rather than new and exciting.

A reader writes in, asking:

“I recently learned about the ‘core allocation’ ETFs from iShares. I haven’t seen these discussed before on Bogleheads or elsewhere, but upon researching they seem like a good option to recommend to anybody who isn’t interested in really managing a portfolio on their own. Any thoughts on the core allocation ishares ETFs?”

The short answer is that I think they’re excellent.

For anybody who hasn’t encountered the iShares Core Allocation ETFs before, they’re funds that (like the LifeStrategy funds from Vanguard) offer a static, diversified allocation. In other words, they seek to offer a diversified portfolio in a single fund.

As far as differences, first and most obviously, they’re ETFs rather than traditional mutual funds. That means you can get commission-free access to the iShares Core Allocation funds at most brokerage firms, whereas generally you must have an account with Vanguard in order to buy the LifeStrategy funds without paying a commission.

In addition, when held in a taxable account, the iShares Core Allocation ETFs are somewhat more tax-efficient than the Vanguard LifeStrategy funds, due to being ETFs. For instance, if you look at the historical distributions of the iShares Core Allocation ETFs, you’ll see no capital gain distributions other than a single one in January 2018 or December 2017 depending on the fund, whereas the LifeStrategy funds make capital gain distributions every year.

As far as costs, the iShares Core Allocation ETFs have expense ratios of 0.15%. That’s ever so slightly higher than the 0.11-0.14% expense ratios for Vanguard’s LifeStrategy funds. In either case, you’re paying somewhat more than what you’d pay with a DIY portfolio of individual ETFs or index funds. But I would not hesitate to describe both the LifeStrategy funds and iShares Core Allocation ETFs as “low-cost funds.” And for anybody who doesn’t want to bother with rebalancing a portfolio, the cost is likely to be worth it.

As far as asset allocation, the overall stocks/bond allocations are as follows:

• iShares Core 80/20 Aggressive Allocation ETF (AOA): 80% stocks, 20% bonds;
• iShares Core 60/40 Balanced Allocation ETF (AOR): 60% stocks, 40% bonds;
• iShares Core 40/60 Moderate Allocation ETF (AOM): 40% stocks, 60% bonds; and
• iShares Core 30/70 Conservative Allocation ETF (AOK): 30% stocks, 70% bonds.

If you’re familiar with the LifeStrategy allocations, you’ll notice that this is very similar, with the one difference being that the iShares Core Allocation ETFs only go as low as 30% stocks, whereas the LifeStrategy Income Fund has a 20% stock allocation.

With regard to the actual underlying holdings, it’s pretty run-of-the-mill stuff. Nothing esoteric in any way. (That’s a good thing!) For instance, here’s the underlying allocation of the iShares Core Aggressive Allocation ETF (AOA), according to Morningstar as of 2/21/2025:

• iShares Core S&P 500 ETF 46.62%
• iShares Core S&P Mid-Cap ETF 2.7%
• iShares Core S&P Small-Cap ETF 1.25%
• iShares Core MSCI International Developed Markets ETF 21.8%
• iShares Core MSCI Emerging Markets ETF 8.29%
• iShares Core Total USD Bond Market ETF 16.34%
• iShares Core International Aggregate Bond ETF 2.83%
• Cash 0.17%

You may notice from the above that the iShares funds have slightly higher international stock allocations and slightly lower international bond allocations than the LifeStrategy funds. Frankly, I like the iShares funds ever so slightly better in that regard.

As I’ve written several times in the past, while I don’t think performance charts are especially useful for deciding which of two funds is better than the other, I do think such charts are helpful for showing how similar (or dissimilar) two funds are. The chart below shows the Vanguard LifeStrategy Moderate Growth Fund (in blue) as compared to the iShares Core 60/40 Balanced Allocation ETF (in red) since December 2011 (i.e., the point at which Vanguard switched the LifeStrategy funds so that they no longer include actively managed mutual funds).

As you can see, they’re very similar.

In short, the iShares Core Allocation ETFs are perfectly fine, boring funds. They’re slightly more expensive than the LifeStrategy funds, with slightly different allocations. And they’re ETFs rather than traditional mutual funds, which makes them more accessible to people with accounts anywhere other than Vanguard and which makes them somewhat more tax-efficient in a taxable account. If you’re looking for a one-fund solution that provides a static allocation, they’re a perfectly reasonable choice.

I’m a firm believer that investing doesn’t have to be complicated and that it doesn’t have to require a great deal of ongoing effort. In that vein, I’m always drawn to “lazy portfolios.” The following are ETF renditions of some of the most popular lazy portfolios.

Most of them could be done just as well using regular Vanguard index funds. The ETF versions simply allow you to implement the portfolios at your brokerage firm of choice. (See here for more about ETFs as compared to index funds.)

1. Allan Roth’s Second Grader Portfolio

• 60% Vanguard Total Stock Market ETF (VTI)
• 30% Vanguard Total International Stock ETF (VXUS)
• 10% Vanguard Total Bond Market ETF (BND)

The asset allocation between the funds is clearly intended for a younger, more aggressive investor. But Roth’s idea of keeping it simple applies to everyone. Even for investors close to (or in) retirement, these three ETFs should get the job done.

2. David Swenson’s Ivy League Portfolio

• 30% Vanguard Total Stock Market ETF (VTI)
• 5% Vanguard Emerging Mkts ETF (VWO)
• 15% Vanguard Europe Pacific ETF (VEA)
• 20% Vanguard REIT ETF (VNQ)
• 15% Vanguard Intermediate-Term Government Bond ETF (VGIT)
• 15% iShares Barclays TIPS Bond (TIP)

David Swenson, the Chief Investment Officer at Yale University, recommends the above portfolio (a 70/30 stock/bond allocation) in his Unconventional Success. He is a big proponent of equity-oriented allocations for investors with long time horizons.

3. Rick Ferri’s Core Four Portfolio

• 36% Vanguard Total Stock Market ETF (VTI)
• 18% Vanguard Total International Stock ETF (VXUS)
• 6% Vanguard REIT ETF (VNQ)
• 40% Vanguard Total Bond Market ETF (BND)

“You only need a few asset classes in your portfolio, and after that there are diminishing returns. The mutual funds you choose to represent those asset classes should be the lowest cost funds you can buy.” –Rick Ferri, CFA on the Bogleheads Forum

4. Bill Schultheis’ Coffeehouse Portfolio

• 10% Vanguard S&P 500 Index ETF (VOO)
• 10% Vanguard Value ETF (VTV)
• 10% Vanguard Small-Cap ETF (VB)
• 10% Vanguard Small-Cap Value ETF (VBR)
• 10% Vanguard Total International Stock ETF (VXUS)
• 10% Vanguard REIT ETF (VNQ)
• 40% Vanguard Total Bond Market ETF (BND)

The title of Bill’s book, “The New Coffeehouse Investor: How to Build Wealth, Ignore Wall Street, and Get on with Your Life” is spot on. The above portfolio is intended to be rebalanced once per year and otherwise left alone. Sounds good to me.

5. Larry Swedroe’s Big Rocks Portfolio

• 9% Vanguard S&P 500 Index ETF (VOO)
• 9% Vanguard Value ETF (VTV)
• 9% Vanguard Small-Cap ETF (VB)
• 9% Vanguard Small-Cap Value ETF (VBR)
• 6% Vanguard REIT ETF (VNQ)
• 3% Vanguard Total International Stock ETF (VXUS)
• 6% SPDR S&P International Dividend (DWX)
• 3% Vanguard FTSE AW ex-US Sm-Cap ETF (VSS)
• 3% WisdomTree International SmallCap Div (DLS)
• 3% Vanguard Emerging Mkts ETF (VWO)
• 40% Vanguard Short-Term Bond ETF (BSV)

You’ll note that Swedroe’s portfolio is significantly tilted toward small-cap and value equities (with the reasoning that their higher risk levels should bring higher expected returns). It’s more funds than I’d personally like, but Swedroe makes a valid point that if you’re only rebalancing annually, the additional effort required by having a few more funds in your portfolio is pretty minor.

6. Harry Browne’s Permanent Portfolio

• 25% Vanguard S&P 500 Index ETF (VOO)
• 25% Vanguard Long-Term Government Bond ETF (VGLT)
• 25% Cash (i.e., money market funds)
• 25% SPDR Gold Trust ETF (GLD)

The idea behind Browne’s Permanent Portfolio is that the four asset classes have sufficiently low correlation that the portfolio should be able to put up modest gains each year under just about any circumstance imaginable.

7. William Bernstein’s No Brainer Portfolio

• 25% Vanguard S&P 500 Index ETF (VOO)
• 25% Vanguard Small-Cap ETF (VB)
• 25% Vanguard Total International Stock ETF (VXUS)
• 25% Vanguard Total Bond Market ETF (BND)

Bernstein, author of The Four Pillars of Investing, suggests the above portfolio for investors with a long time horizon. Note that it’s very similar to the first portfolio mentioned above (Roth’s Second Grader Portfolio), but with a much heavier allocation toward small-cap domestic stocks.

8. Harry Markowitz’s “Father of Modern Portfolio Theory” Portfolio

• 50% Vanguard Total World Stock ETF (VT)
• 50% Vanguard Total Bond Market ETF (BND)

Harry Markowitz–Nobel Prize winner and originator of Modern Portfolio Theory–when asked about his personal portfolio once replied, “I should have computed the historical co-variances of the asset classes and drawn an efficient frontier…Instead, I split my contributions 50/50 between bonds and equities.” The above portfolio is a somewhat tongue-in-cheek implementation of Markowitz’s approach.

Thoughts?

Do you have a favorite? Does your portfolio closely resemble any of the above? (For those curious, mine looks very much like the Second Grader Portfolio.)

Update: Monevator has written a revision of this article outlining Lazy ETF Portfolios for UK investors.

Last year, I came across a new brokerage firm called Betterment that promotes hands-off, passive investing with ETFs. Despite that being right up my alley, I didn’t write about Betterment at the time because I thought their costs (0.3%-0.9% per year) were just too high.

Recently, however, they dramatically reduced their costs (details below), so I thought it would make sense to take another look to see if they might be a good fit for any particular types of investors.

Before you ask: I have no affiliation with Betterment, and this post is not sponsored by them in any way. They do, however, have an affiliate program, so it wouldn’t hurt to be careful about what you read about them online. (If you don’t know what an affiliate program is, I’d encourage you to read this post.)

How Betterment Works

In short, Betterment creates an ETF portfolio for you based on your risk tolerance, and they rebalance it quarterly as well as any time the account’s allocation strays more than 5% from the desired allocation. There’s no fee for the rebalancing transactions or for putting money into or taking money out of the account.

Instead, according to their new cost structure, there is a simple ongoing fee based on the amount you have invested with them:

• 0.35% per year for investors with less than $10,000,
• 0.25% per year for investors with $10,000 to $100,000, and
• 0.15% per year for investors with more than $100,000.

For Investors with Less than $100,000

For investors with less than $100,000, you only get to choose the overall stock/bond allocation. From there, Betterment breaks it down as follows:

For the stock portion of the portfolio:

• 25% Vanguard Total Stock Market ETF
• 25% iShares S&P 500 Value Index ETF
• 25% Vanguard Europe Pacific ETF
• 10% Vanguard Emerging Markets ETF
• 8% iShares Russell Midcap Value Index ETF
• 7% iShares Russell 2000 Value Index ETF

For the bond portion of the portfolio:

• 50% iShares Barclays TIPS Bond ETF
• 50% iShares Barclays 1-3 Year Treasury Bond ETF

Based on those funds’ expense ratios, an investor’s annual costs before considering Betterment’s fee would be approximately 0.17%. Once you add in Betterment’s fee, we’d be looking at all-in costs of either ~0.42% or ~0.32%, depending on whether you have more or less than $10,000 invested with them.

In other words, at these asset levels Betterment is analogous to an all-in-one fund with:

• A value tilt for the stock portion,
• Exclusively Treasury bonds for the bond portion, and
• Costs that are much lower than industry averages, but still higher than what you’d pay for a LifeStrategy or Target Retirement fund at Vanguard.

For most investors at this asset level desiring a hands-off solution, I would still suggest using an all-in-one fund from Vanguard — with the exception being investors who prefer Betterment’s allocation strongly enough to pay an extra quarter of a percent for it per year.

For Investors with $100,000 or More

For investors with $100,000 or more, Betterment provides the option to create a “custom portfolio.” Frankly, I think this is where the service provides something not offered elsewhere. For investors in this category, Betterment would be a way to essentially create your own all-in-one fund. For example:

• For investors with no choice but to own bonds in a taxable account, it could be a way to create an all-in-one fund that uses tax-exempt bonds.
• For investors looking to tilt heavily toward REITs or small/cap value stocks, it could be a way to do that.
• For investors looking to have a very high or very low international allocation, it could be a way to do that.

In Summary

I’m very excited about what Betterment is doing. I think it’s wonderful to have more firms in the marketplace that encourage the use of a “buy, hold, and rebalance” strategy using a diversified portfolio of low-cost funds.

At the same time, I think Vanguard is already doing a great job of meeting most investors’ needs, and they’re doing it at a lower cost.

That said, for investors who:

• Want a hands-off solution,
• Are not a good fit (for one reason or another) for the allocation of any of Vanguard’s LifeStrategy or Target Retirement Funds, and
• Have $100,000 or more to invest…

…I think Betterment’s offering is worth looking into.

For investors who have only recently decided to switch their portfolio to low-cost, indexed investments, one of the questions that must be answered is whether to use ETFs or traditional index funds. We discussed this issue a couple of years ago here on the blog, but many things have changed since then.

Comparing Expenses

Two years ago, arguably the biggest factors in the decision were that ETFs had lower expense ratios than most index funds, but you had to pay a commission to purchase them. Since then, however, multiple brokerage firms (most notably, Vanguard, Fidelity, Schwab, and TD Ameritrade) have begun to allow for commission-free trades of certain low-cost ETFs.

On the other hand, ETFs no longer offer much (if anything) in the way of savings with regard to expense ratios. If you have $10,000 or more to invest in a given fund, you can have access to the “Admiral shares” version of most Vanguard funds, which usually have expense ratios as low as the lowest-cost ETFs. (Prior to October 2010, the Admiral shares had a minimum initial investment of $100,000 rather than $10,000.)

In short, when it comes to expenses, there is no longer a significant difference between the lowest-cost ETFs and the lowest-cost index funds.

Tax-Efficiency

Much has been written about the difference in tax-efficiency between ETFs and traditional index funds. Some people argue that ETFs have lower tax costs, while others argue exactly the opposite. As far as I can tell from comparing Morningstar’s “tax cost ratios” for several index funds and comparable ETFs, it’s not entirely clear which side of the argument is correct.

What is clear though is that both index funds and passively managed ETFs are far more tax-efficient than the majority of their actively managed counterparts — primarily due to the fact that passively managed funds have much lower portfolio turnover than actively managed funds.

More Important Considerations

For most investors, because of the industry changes in recent years, the ETF vs. index fund decision now comes down to considerations other than costs.

It makes sense to use ETFs if you care about:

• Buying or selling your holdings in the middle of the day, or
• Using types of orders other than market orders (limit orders, for instance).

Conversely, it makes sense to use traditional index funds if you care about:

• Being able to buy fractional shares, or
• Setting up automatic purchases (or sales) at regular intervals.

Personally, I don’t particularly value the advantages offered by ETFs, so I choose to use traditional index funds. For other investors, ETFs will be a better fit.

In any case, for investors using a “buy, hold, and rebalance” strategy, the differences between low-cost ETFs and low-cost index funds are slim. Your long-term success is unlikely to be affected either way as a result of the decision.

From time to time I see financial writers lamenting the explosion in ETF popularity over the last few years. They complain that the original idea of index investing (i.e., buying and holding a low-cost, diversified portfolio) has been perverted in favor of a focus on trading ETFs for short-term profits.

Frankly, I disagree. I think the proliferation of ETFs has, on the whole, been great for investors.

(Quick note: I’m not arguing that ETFs are better than the index funds that already existed. Nor am I saying that most investors should be buying ETFs on margin, day trading them, or buying sector-specific ETFs.)

More Access to Low-Cost Investments

A couple decades ago, pretty much the only way to build an indexed portfolio was to have an account at Vanguard. Today, anybody with a discount brokerage account has access to the tools with which to put together a low-cost, diversified portfolio.

Is that bad for investors?

Price Competition

Over the last year or so:

• Schwab created their own commission-free ETFs,
• Fidelity responded by working out a deal with iShares to offer commission free trades on iShares ETFs, and
• Vanguard eventually replied by allowing for commission-free trades of Vanguard ETFs.

It’s price competition in action, and I doubt it would have happened if it weren’t for the massive demand for ETFs.

Is that bad for investors?

Cost Awareness

We’re naturally cost-conscious in most areas of their lives. We do our best to save money on groceries, utility bills, back to school supplies — everything. Everything, that is, except for investments.

For decades, investors have been paying through the nose for mutual fund portfolios. And we’ve been doing it without even realizing it.

That’s finally changing. More and more investors are becoming cost-conscious about their portfolios. And ETFs are (at least in part) to thank for that.

For example, when Fidelity and Schwab each promoted their commission-free ETFs, they promoted the low-cost aspect of it. There were full-page adds in financial magazines encouraging investors to pay attention to expense ratios and commissions per trade.

Is that really so bad?