Which is better: TWF or USF?
2 Oct, 2022
This week I’m answering a question that Paul has sent to me, and it is a question that I’ve been dwelling on myself. I’m going to do my best not to get too deep in the weeds with my answer; you can let me know in the comments below if I have succeeded or not! It might sound like a niche question, but the answer I give is, in my opinion, widely applicable to investors.
But firstly, for those who might be new to the terminology, let me explain the title:
Which is better: TWF or USF?
I’m referring to two Smartshares ETFs (exchange-traded funds):
The Total World Fund (ticker code TWF)
The US 500 (ticker code USF)
The Total World Fund invests in emerging and developed countries globally (but 60% of the fund is U.S. shares because their economy is so huge). In comparison, the US 500 fund holds only the top performing 500 companies in the United States.
Big disclaimer: I’m not a financial advisor; I can’t give financial advice. But I do have an opinion.
Here is Paul’s question:
Kia ora Ruth,
I just wanted to get your perspective on ETF investing. I had settled on a 100% investment in Smartshares US 500 (USF), purchased through the InvestNow platform. I was really confident with this decision, but after listening to a podcast with JL Collins and The Rebel Finance School, it threw me in a bit of a spin!
They advocated that those living outside the U.S. should opt for a Total World Fund (TWF) instead. This does make some sense to me in terms of increasing diversification geographically.
JL's initial reasoning hasn't changed for investing in the US 500. A lot of the US 500 companies are still global companies. Why is US 500 still an acceptable thing?
Anyway, with my wee wobble, I kept my US 500 shares, but I switched to now only investing TWF. The trouble is, US 500 trends look sooo much better than TWF, not to mention US 500 bouncing back well in the past year.
I know that “past performance is not a predictor of future returns”, but still:
USF: 5 Years Annualised Returns (after fees .34%, after-tax 28%) = 13.91%
TWF: 5 Years Annualised Returns (after fees .40%, after-tax 28%) = 8.89%The USF looks pretty good, and it would be nice to have that extra 5.02% return and 0.06% lower fee!
I am keen to stay with one ETF and understand TWF is pretty heavily weighted to the U.S. share market anyway (60% of it are U.S. shares), but just wondering if it is tooo diversified with the other countries bringing actual returns down.
So US 500 vs TWF - what are your thoughts?
Ngā mihi
Paul
I also listened to the JL Collins on Rebel Finance School - The Simple Path to Wealth Week 7 webinar. I, too, was surprised to hear his advice that those outside the U.S. might want to consider buying the TWF, given that he has always advocated “just buying the VTSAX” (Kiwis use a different version of this which is called the US 500, ticker code USF).
I would encourage you to listen to his entire talk, but he specifically mentions today's topic about 45 minutes into the video.
To paraphrase JL Collins:
He doesn’t buy international stocks. He owns the largest companies in the U.S., held in the VTSAX fund. Think Apple, Microsoft, Facebook, and Tesla. He believes world economies will grow, but he doesn’t need to invest outside of the U.S. to partake in their prosperity.
But, he said that if he were outside of the U.S., he would buy a TWF because he would not feel comfortable investing 100% in a country ‘other than his own’. It is his view that sometime in the far (f a r) distant future, i.e. long after he is dead and buried, the U.S. economy may shrink in dominance. At this time, it would make sense to invest more internationally to capture those other growing economies.
But for now, he is happy with his 100% U.S. allocation. He said that after World War II, the U.S. economy used to make up a far more significant part of the international pie, and 70 years later, it’s currently at about 60%. He argues that the trend is not alarming at all, to have the U.S. as a smaller percentage of a bigger global pie. Right now, he said, he can get away with owning just the U.S. market.
But if he were Paul, who is not U.S. based, he would invest in a Vanguard Total World Fund. His point is to not bet on any one economy; instead, “you are betting on the world continuing to prosper”. I share his optimism for a prosperous world.
Fascinating stuff, you will all agree.
So, where does that leave Paul? And myself, for that matter. I have a growing investment in that US 500 fund.
This blog post took me a week to write because I kept thinking about and diving into the nuances of both choices here. I’ve been on Reddit threads, blogs and company websites looking for clarification, getting bogged down in detail and the random opinions of random people on the internet.
But essentially, I am ignoring it all.
Because one other thing that JL Collins and others like him consistently say is:
“Pick a low-cost index fund, invest as much as possible, as often as possible, and hold it forever.”
He also says, “don’t jump off the ride halfway through”.
Paul has jumped off the USF train ride, is clambering aboard the TWF train ride, and is now questioning his decision, particularly in light of these past returns:
USF: 5 Years Annualised Returns (after fees .34%, after-tax 28%) = 13.91%
TWF: 5 Years Annualised Returns (after fees .40%, after-tax 28%) = 8.89%
“The USF looks pretty good, and it would be nice to have that extra 5.02% return and 0.06% lower fee!”
How can I help Paul feel comfortable again?
For anyone wondering about any financial decision, I would encourage you to think about your investments in the broader context of your entire life.
In other parts of your life, do you micro analyse the decisions you are about to make, constantly chop and change to chase a better outcome and try with certainty to predict an unpredictable future? Having done all that, do you then revise the result of each of those decisions?
Nope. That would be exhausting.
Did you choose your current career due to absolute financial gains, confirmed contentment at work and 100% emotional happiness? I would argue that while you put a bit of thought into it, ‘rough enough’ was good enough because although you had an idea of what your job would entail, you understood that you could never know with certainty what you were headed into.
Do you live in the particular home you do because it optimises your life? The size, location and price of your home met every criterion you had written down in your spreadsheet? Probably not. It is more likely that you made your choice based on what house was available to rent or buy in your size and price bracket. Could you have chosen a better house? Probably? Are you doing anything to change it? Probably not.
How about that partner of yours? Are they shaping up to be 100% perfect? Highly unlikely, but hey, you make do, right?
Is your day spent optimising the allocated 1440 minutes you have available so that you can be your best physical, mental, emotional and financial self? Or do you have a relatively predictable routine that works 80% of the time? And you make adjustments for the other 20%.
Do you buy a car, then swap it for another after you drove downtown and saw something you thought might be ‘better’ drive past? Highly unlikely. The vehicle you are already in is good enough for now.
In that same webinar that Paul is referring to, the host, Katie, constantly says, “it is not binary. It’s never just 1 or 0.” There is a diverse spectrum of options and opportunities, and you pick and choose the best way you can, based on where your life is at that moment in time.
We are all a little sub-optimal, and that is OK.
I think most of us just go about our daily lives constantly making decisions that, in hindsight, might be sub-optimal. Or they might not be. But for some reason, when it comes to investing, we feel we have to get it exactly right all the time, which is impossible.
So, Paul, the choice is yours, and you can choose between two great options. One is “good”, and the other is “good”. But you won’t know until later which was which, therefore you just need to make your choice.
Do you want to just buy the top 500 companies in the U.S., knowing that many are international?
Or do you want to buy the whole world fund, in which 60% of the companies are the U.S. anyway? Just to emphasise the weighting of U.S. companies in a TWF fund, look at the image below. In case you were wondering, New Zealand is #34 and represents 0.1% of the world in this fund, of which there are approximately 49 countries:
FTSE Global All Cap Index Market Allocation: The Smartshares Total World ETF invests in the Vanguard Total World Stock ETF, which is designed to track the return on the FTSE Global All Cap Index. Click on the image to enlarge.
Source: www.vanguardinvestor.co.uk
How diversified is too diversified?
Paul made another point about being “too diversified with the other countries bringing actual returns down”. I can’t answer that, and it makes my head ache to think about it. But I do find it interesting that the list above very quickly gets down into tiny percentages. Without spending days speaking with global economists and trying to wrap my head around just which part of my investment mix is dragging down returns, the honest answer is that I simply don’t know. I also don’t know because as I moved down the list of the 49 countries, I could barely find some of them on a map, let alone know their main industry source. So I just don’t sweat that detail. Which I know is not what you want to hear from a blog on personal finance. If you want to negotiate the minutiae of detail on that, Money King NZ willingly dives into such detail.
Past returns give you the vibe of future returns.
And although we know “that past returns don’t predict future returns”, they do give a good indication of the direction the market is moving in. Given that humans are terrible at predicting the future, I do use past returns to guide my future returns.
So, when you look at those two funds, you need to ask yourself, Paul, how long do you think it will take for that gap in returns to close? How soon do you predict the demise of the US 500, and how soon do you think other international economies will pick up that slack? What is the state of the economy of each of those 49 countries that makes you confident they will rise in value?
Each company and country is trying to grow.
Suppose every staff member of every company in the US 500 fund goes to work every day with the explicit intention of making their company that little bit better. In that case, I have confidence that, over time, the value of the shares of those companies will rise.
I can only suppose that it is the same for every company in every country in the world.
Every single day, companies are trying to win and succeed. But blips happen, as we have recently seen. Covid came along and significantly impacted vast sectors of the economy, and many companies faltered. Some failed. But equally, many saw an opportunity to grow, so they forged ahead with huge growth.
I’m not betting on the U.S. to fall to pieces anytime soon (but what would I know), and most times that something falls to pieces, none of us saw it coming. I am betting on the U.S. and each country in the world to try and grow, but I just don’t know who will grow fastest.
Each of these two funds is low in fees, as diversified as you can get, have a long track record and is passively managed. And because they ‘self cleanse’, so to speak, dropping out the poor performers and replacing them with the next top performer, I don’t have to spend my days recalibrating my investment.
Look at your investments as a whole.
I think that what is most important to keep in mind here are those golden rules of investing that JL Collins and many others refer to:
“Pick a low-cost index fund, invest as much as possible, as often as possible, and hold it forever.”
I believe that what is more important is to focus on consistently contributing to one of these funds over time and don’t look at it in isolation. Instead, consider it as part of the rest of your investments.
In my case, I sleep perfectly well with my choice because I have actually diversified globally. I own:
The USF
KiwiSaver, of which 53% is in international shares
NZ 50 because I have what is referred to as “hometown bias”. Of course, I think Aotearoa is going to keep growing and succeeding!
My home
After educating yourself, researching widely, and looking at your investment mix, set your own parameters and settle in for the ride.
Predictions are not factual.
Predictions are announced with such confidence that they sound like facts, yet no one back costs anything anyone ever said on a Reddit thread or in the business news. Everyone is just guessing. So, don’t let a market commentator, your best mate, JL Collins, or myself sway you from the investing path you have researched and chosen for yourself.
Which of these funds will perform better over time? We have no idea. No clue, but you have a better chance at financial success than someone who didn’t join the ride.
I have no idea how much Paul has invested, but I know that in New Zealand, we feel entirely comfortable with a house valued at $1,000,000, yet we freak ourselves out if we have $10,000 in one ETF. I’m the opposite. I’d rather build a vast and diversified share portfolio using an ETF and my KiwiSaver than have all my money in one house.
To make investors feel comfortable, I would encourage you to set some guidelines for yourself to build up your understanding and confidence.
For example, in my US 500 ETF, I began my investment with just $50. I told myself I would review it at $1000. By this time, I’d had a chance to learn a little more, watch how the investing process worked etc. Next, I said I’d review it at $10,000. When I got to that point, I looked at how it had been performing, whether I understood this investment, and whether I was still content. The answer was yes; the following review was at $50,000, then $100,000. And onwards.
Using incremental steps, we can review the trajectory we are on.
This avoids us jumping off the ride halfway through. Outside of those review points, I just set and forget, leave it alone and invest as much as possible into the funds I’ve chosen.
And in the meantime, I give it zero thought. Paul, that is what I want for you too.
I hope that helps answer your questions. Thanks for asking them. I enjoyed thinking about it, even though it frazzled my brain many times.
