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3 Fund Moat Portfolio to Beat All

There are plenty of reasons one might not wish to manage a portfolio of individual stocks. If I’m being honest, I’ve been there. No judgement here.

I still hold that the best way to manage your stock portfolio is to own individual stocks. By owning the stocks you ensure that your portfolio is holding only quality stocks. When you own funds (either exchange traded funds or mutual funds) you have no control of what you own. Even with a solid manager you might end up with some questionable companies.

First, a diversion

Before I get too far, there are ETFs that only hold stocks that have a Wide Moat rating from the investment research company Morningstar. The fund I’m referring to is the VanEck Morningstar Wide Moat ETF (ticker: MOAT). While not a bad option, I’m not a fan. My issue with this fund is how it’s managed. The fund is positioned based on relative valuation to Morningstar fair value estimates. Every six months a rebalancing takes place. The rebalance brings in stocks with a low price to fair value ratio and sells the stocks with high ratios. The result is a portfolio turnover of over 50% per year.

VanEck’s strategy makes no sense to me as a long-term investor. I want to own good companies for the long-term. To put a finer point on it, the Morningstar’s moat rating that VanEck uses is based on long-term outlooks. Using long-term research to make valuation based trading decisions is nonsense. Growth stocks move wildly between over and under fair valuation. It’s a fool’s errand to attempt trading in and out of a stock based on valuation estimates. For example, I’ve never met anyone that traded Amazon to a higher return than simply holding the shares over a long stretch of time.

On the Hunt

Yes, a portfolio that has wide moat in the name is not a good option for a true long-term investor.

Fear not. There are ways to hold a portfolio of quality, moat stocks using a small number of ETFs. Part of the trick is to look for funds that have a theme or strategy that leads to a portfolio of moat stocks. Two terms that can help narrow the search to find a portfolio of moat stocks are growth or profitability.

Let’s be clear not all moat stocks are growth stocks. Plenty of wide moat stocks are not consider growth stocks. Rather, they are steady, slower growing stocks that pay dividends. Thankfully, one trait all investment-worthy moat stocks share is profitability.

When searching for a solid, moat-oriented ETF to use for your portfolio start with looking for an ETF with over $150 million in assets. Funds that clear this hurdle seldom close due to little traction. After that, look in the large-cap, mid-cap and international space. Then drill down to look for growth orientation or profitability focus in the investment objective of the fund.

A 3 Fund Portfolio

In most investment realms I would be mocked for suggesting you can have a diversified portfolio with holding three funds. Fact is, even holding my three fund lineup outlined below, you will be over diversified if you consider all the stocks you will own across the three holdings. Plenty of ink from academic research has been spilled on how many stocks can make a diversified portfolio. The answer is that holding a diverse portfolio of anywhere from 17-40 stocks achieves all the diversification you need. With this 3 fund portfolio wou actually will own hundreds of stocks. But, most of the performance will come from the top 25 holdings of each fund.

None-the-less, this is a solid portfolio for building long-term wealth.

To cover the US market use the Dimensional Fund US High Profitability Fund (ticker: DUHP). Although it’s a relatively new fund, the fund advisor and the strategy are solid. You would be hard pressed to find many high profitability companies that do not have a moat. Consider the top holdings of this fund from Yahoo Finance.

To cover foreign markets use the iShares MSCI EAFE Growth Fund (ticker: EFG). A little inside baseball is that EAFE stands for Europe, Asia, Far East. The top holdings lineup of this fund is a who’s who of foreign moat stocks. Consider the top holdings of this fund from Yahoo Finance.

I like having a fund to balance the portfolio for periods of market weakness. For this slot I’m adding the moat-riddled iShares Global Consumer Staples ETF (ticker: KXI). Many of these stocks will not be in the other two holdings. But, these are significant moat companies that will offer some downside buffer in weak economic times. Consider the top holdings of this fund from Yahoo Finance.

Conclusion

There you have it, a three fund, diversified, global, moat-oriented portfolio. I know you have one last question. How much of each should I own? There is no need to make this complicated. See how 1/3 in each works for you. If you are feeling more aggressive trim KXI and increase the other two. If you are feeling more conservative then trim DUHP and EFG and increase KXI. Good luck out there!