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The Barefoot Investor on Index Funds

If you aren’t conversant with The Barefoot Investor, it’s among the most sought after Australian finance books. Currently, it’s the number one selling book in personal finance. In this article, we’ll go over the different index fund portfolios that have been built and recommended by the Barefoot investor over time. 

Who’s The Barefoot Investor?

The Barefoot Investor is a blunt guidebook to taking charge of your finances using practical and simple steps that every Aussie can follow. One of Pape’s significant lessons in the guide is how to automate one’s retirement through venturing into index funds.

 

The Barefoot investor is currently among the most reliable finance gurus in Australia, often speaking on national television to offer advice to ordinary Aussies. 

 

As far as investing is concerned, Scott used to have a paid periodical called the Barefoot Blueprint, where he shared EFT and stock recommendations. Pape even shared a few Index tracker portfolios that we’ll go over in this article. 

What’s An Index Fund?

Before we delve into Scott Pape’s Index Funds, let’s define what index funds are. An index fund is a type of EFT or mutual fund with a portfolio built to track or match components of an investment market. 

 

Index funds may have various individual shares. However, you have to make a single buy to own a part of them.

 

Using index funds is easier than self-managing many portfolios of different firms and regularly trying to readjust weightings each day. The best property of index funds is in their name — they passively monitor an index. 

 

Indices are a set of trading stipulations that the funds have to abide by. For instance, an index tracker that trails the ASX 200 monitors the performance of the 200 biggest Australian firms listed on the ASX. 

 

In a world where index funds didn’t exist, if someone wanted to have a thousand different shares in their portfolio, they’d have to make 1,000 separate purchases. If it costs $10 per stock, that will amount to $10,000 alone just purchasing the firms. 

 

The main advantage of owning many different shares is diversification. If one owns five individual stocks in their share portfolio and one stock goes under, you’ll lose a lot of cash.

 

If you purchase the whole ASX200 index tracker, you’ll have 200 separate shares and firms contributing to your net profit. Thus, if one stock goes bust, it doesn’t matter since you’ll have 199 other shares.  

Scott Pape’s Two Cents On Index Funds

Let’s now delve into Scott Pape’s (the Barefoot investor) outlook on index funds. His thoughts on the matter are somewhat confusing. 

 

On the one hand, Scott Pape is an enthusiast of passive fund trackers and their benefits since he touches on them in a few chapters. 

 

The book mentions a renowned American Financial research company, Dalbar, which has monitored investors’ actual profits for decades. 

 

Based on their research, Dalbar had established that the ordinary investor earned 3.7% yearly over the last three decades when the simple index fund yielded 11.1% annually. The everyday investor failed the equity market by roughly 7.4% every year for 30 years.

 

Scott Pape also mentions Warren Buffett, a leading investor globally. The latter planned to leave his spouse her whole inheritance in a basic index tracker that automatically purchases the 500 biggest firms in the U.S, such as Google, Amazon, Nike, Apple, Facebook, and McDonald’s. 

 

The Barefoot investor’s super is similar to Warren’s. However, it also has 200 leading Australian firms — BHP, Telstra, and Banks. 

 

Surprisingly, the superannuation index tracker that Pape endorses, Hostplus’ Indexed Balanced Fund, is an indexed Tracker superannuation alternative! From these portions in the book (amongst others), Scott Papes understands that inexpensive, passively held index trackers are the best way to invest for the average Aussie. 

 

Nevertheless, when it comes to the part in the book on making investments outside of your superannuation, Scott Pape doesn’t put forward a passive index fund. Instead, he recommends an actively controlled Listed Investment Company (LIC) on the ASX. 

 

What’s confusing is that until recently, Scott Pape used to have a periodical — The Barefoot Blueprint — where he would give his followers individual shares tips and recommendations. As mentioned earlier, these stocks would significantly fail an index. 

 

In 2019, he shut down the newsletter production. Fortunately, before shutting it down, he shared several Index Tracker Portfolio strategies that we’ll go over below. 

Scott Pape’s Index Fund Portfolios

1. The Idiot Grandson Portfolio

In this portfolio, the asset allotment strategy used a blend of EFTs that put money into the United States, International, and Australian stock. This portfolio aims to be a lifelong investment that will generate a steady income flow that can be handed down through generations. 

 

Scott Pape assessed over 114 LICs and 201 EFTs on the ASX list to identify the best investments in this portfolio. He utilised a three-part filtering procedure to decrease the index funds from 315 to 10. 

The Filtering Procedure

Step 1: Removing High Fees

The initial cut that Scott Pape used here was straightforward. He got rid of any index funds with a management fee of over 0.40% p.a. This brought down the number of LICs from 114 to ten and EFTs from 201 to 60. 

Step 2: Removing Undesirables

The second filter that Scott Pape used to bring down the index fund count was removing any undesirable funds. This process was subjective, and the unwanted funds included:

 

  • Small-cap Funds: Scott Pape eliminated funds solely focused on small-caps due to their above-average volatility
  • Synthetic: The Barefoot investor got rid of any funds that involved using derivatives or were synthetic; this included any internally leveraged funds
  • Outliers: He removed funds that specialised in specific strategies or areas since they weren’t broad. This included high-yield dividend harvester funds, which don’t have great total returns in the long term
  • Industrial Funds: The Barefoot Investor removed any industrial funds since they don’t track a broadly diversified index
  • Equal-weight Funds: Finally, Scott Pape removed all equal-weight index funds since they don’t monitor a market as closely as a market-weighted fund

 

After the second cut, Scott Pape had 6 LICs and 13 EDTs remaining. 

 

Step 3: Style Of Management

The final cut was more subjective than the second one as it involved going over the management techniques of the remaining index funds. Scott Pape focused on index funds that weren’t purely for profit. This left the Idiot Grandson with ten funds remaining. This included:

Australian Index Funds:

  • ARG: Argo Investments (LIC)
  • AFI: Australian Foundation Investment Company (LIC)
  • DUI: Diversified United Investment Company (LIC)
  • AUI: Australian United Investment Company (LIC)
  • VAS: Vanguard Australian Share Fund (ETF)
  • MLT: Milton Corporation (LIC)

Global Index Funds:

  • Vanguard MSCI Index International Shares (ETF)
  • Vanguard All-World ex-US Shares Index (ETF)
  • Vanguard MSCI Index International Shares (ETF)

American Index Funds:

  • VTS: Vanguard US Total Market Shares Index (ETF)

 

The allotments Scott Pape recommends are 10% U.S. shares, 15% Global shares, and 75% Australian stocks. If you wish to follow the Barefoot Investor’s portfolio guide, the simplest and lowest selections would be as follows:

 

  1. Vanguard Australian Share Fund (VAS): 75%
  2. Vanguard All-World ex. US Shares Index (VEU) : 15%
  3. Vanguard US Total Market Shares Index (VTS):  10%

 2. The Breakfree Portfolio

This was the first Index Portfolio that Scott Pape shared in his exclusive periodical. He shared this portfolio with the premise that it’s simple to manage. The portfolio comprised 5 EFTs he proposed to rebalance once a year to stick to the suggested percentage allotments. Each EFT was in a particular sector, being:

 

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

STW (ASX Large-caps)

State Street runs this EFT, and it monitors the ASX200 Index. It aims to catch future share growth opportunities, franking and dividends credit given by the 200 most prominent and liquid publicly traded companies in Australia’s equity market. This EFT has a 0.13% management charge and has yielded over 8% annually since its inception more than two decades ago. 

 

Scott Pape recommends having a 35% allocation in this EFT since he favours Australian Equity allotments. The ASX 200’S large caps are reliable and have a reasonable dividend yield. 

VAP (Australian Property)

VAP is a Vanguard EFT that monitors the ASX/S&P 300 A-REIT index. VAP’s goal is to put money into property securities on the ASX to give exposure to commercial and residential real estate. 

 

This EFT has a 0.23% yearly management fee and has yielded more than 11% annually since its establishment in 2010. 

 

Scott Pape suggests having a 20% allocation in this EFT to get Australian property sector exposure. 

IOO (Global Large-caps)

This is the first EFT that offers exposure beyond the ASX.  Scott Pape endorses having a 20% allocation in Blackrock’s IOO. The EFT’s goal is to give investors the S&P Global 100TM index’s performance before expenses and fees. 

 

The EFT is designed to monitor how the top 100 global blue-chip firms of significant importance in the world equity markets perform. This EFT has a 0.40% yearly management charge and, since its establishment in 2018, has yielded 4.3% annually.

 

Nonetheless, the index its monitoring has been around longer and, in the last decade, has returned more than 16% annually. 

 

Scott Papes suggests having a 20% allotment in this EFT to get exposure to global big-cap firms. This EFT is a much-required shift from over-exposure to the Australian equity market. 

VSO (Australian Small-caps)

Vanguard runs this EFT, and it monitors the MSCI Australian Stock Small Cap Index. Its goal is to offer diversified exposure to small organisations listed on the ASX.  It has a 0.30% annual management fee and, since its foundation in 2011, has returned 7.58% annually. 

 

Scott Pape recommends having a 15% allocation to diversify your concentrated Australian holdings. 

VAF (Australian Fixed Interest)

Lastly, to close this Portfolio, the Barefoot Investor recommends having a 10% allotment in Vanguard’s VAF EFT. This EFT monitors the performance of top-quality Australian bonds. The EFT has a 0.20% annual management fee and, since its establishment in 2012, has yielded over 4% annually.   

 

Given the wide demographic of Scott Pape’s audience, it’s logical to have an allotment in fixed interest-bearing bonds to decrease the portfolio’s overall volatility.

Portfolio Summary

Generally, this is, without a doubt, good. However, it’s too concentrated on the Australian equity market. Additionally, the general management charges are quite high. 

The Barefoot Investor’s Simplified And Improved Index Fund Portfolio

There’s a more straightforward way to build Scott Pape’s Index Fund Portfolio using 2 EFTs. This is through the Vanguard International Shares Fund (VGS) at 75% allocation and a 200 EFT 25% allocation. This consists of 25% Australian exposure and 75% International exposure. VGS doesn’t include Australian stock. 

 

There’s an easy way to automate this process and put your investing on autopilot. That’s through Pearler, an investment platform that’s available in Australia. Pearler’s auto-invest feature lets users configure predefined investments, like how EFTs follow an index. 

 

Therefore, a user can instruct it to put money into VGS 75% and A200 25%, set up their deposit schedule, and handle the rest. 

Final Thoughts

The Barefoot Investor Index Fund Portfolios are more complex than necessary and have too much exposure to the Australian equity market. The best approach is to keep it as simple and low-cost as possible when investing in Index funds. 

 

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