Why not just invest in the S&P 500 ETF?

Your Purposeful Investor host, Aden Wilkins, is joined by Investment Committee members, Nick Menegola and Dr. Steve Garth to answer a listener’s question: “Why not just invest in the S&P 500 ETF and a bond ETF? Isn’t that enough?”

Listen via the link above or read the Q&A summary below.

The S&P 500 represents the 500 largest companies listed on US stock exchanges, making it a strong example of a growth asset. A bond ETF, on the other hand, represents defensive assets. But deciding how much of each to include in a portfolio isn’t a one-size-fits-all approach.

When constructing a portfolio, we start by asking three key questions:

• How much risk do you need to take?
  This is about what return your portfolio needs to generate to meet your financial goals. The higher the required return, the more exposure you’ll need to growth assets like shares.
• How much risk can you afford to take?
  While shares tend to perform well over the long term, they can be volatile in the short term. We assess your financial situation to ensure you’re not overexposed to risk you can’t afford.
• How much risk can you tolerate?
  This is about your comfort level. Can you sleep at night knowing your portfolio might fluctuate? Your emotional tolerance for risk is just as important as your financial capacity.

These three questions help determine your asset allocation—whether that’s 70% growth and 30% defensive, or another mix entirely. This decision is the most impactful one you’ll make in shaping how your portfolio performs through market ups and downs.

Australian and international shares

Q: If I’m investing in growth assets like shares, how should I decide how much to allocate to Australian versus international markets?

A: There’s no perfect formula, but several key considerations guide this decision:

1. Start with a global market perspective: A common starting point is the global market capitalisation index, which weights countries based on the size of their markets. Currently, the US dominates this index, while Australia makes up only about 2%. However, most Australian investors hold a much larger portion—often 30–50%—in Australian shares. Why overweight Australia? There are three main reasons:
   1. Home bias: Investors tend to prefer companies they know. In Australia, that often means banks, miners, and other familiar names.
   2. Franking credits: Unique to Australia, franking credits prevent double taxation on dividends. This can significantly boost after-tax returns, especially for retirees or those in low-tax environments.
   3. Currency considerations: Investing internationally introduces foreign exchange risk. You can choose to hedge this risk or leave it unhedged, but either way, it adds complexity.
2. Income vs growth: Australian shares typically offer higher dividend yields, making them attractive for income-focused investors. In contrast, US and other international shares often focus more on capital growth.

Q: So, should I just follow the global index or adjust it?

A: Most investors adjust it. While the global index is a good starting point, overweighting Australia can make sense for tax efficiency, income generation, and familiarity. Just be mindful not to overdo it—diversification remains key.

Investment considerations

Q: The US market has been performing really well—why not just invest everything in the S&P 500?

A: It’s true that the US market, particularly the tech-heavy NASDAQ, has delivered exceptional returns in recent years. Companies like Apple, Microsoft, Meta, and NVIDIA have driven much of this growth. But relying solely on one market—even one as dominant as the US—comes with risks:

1. Short-term outperformance isn’t guaranteed long-term: While the US has outperformed recently, history shows that leadership rotates. For example, during the early 2000s tech crash, Australia significantly outperformed the US. Over the long term, different markets shine at different times.
2. Diversification reduces risk: Just as you wouldn’t invest in a single stock, it’s risky to invest in a single country. If the US underperforms or experiences a downturn, a globally diversified portfolio can help cushion the impact. Other economies may perform better during those periods.
3. US companies are global—but still US-centric: Many top US companies operate globally, but they’re still influenced by US economic and policy conditions. A diversified portfolio includes exposure to other regions and sectors that may behave differently.
4. Valuation and volatility: High-performing sectors like tech can also be the most volatile. When markets get jittery, these stocks often fall the hardest. Diversification helps smooth out those bumps.

Q: So what’s the takeaway?

A: While US shares are an important part of a global portfolio, concentrating too heavily in one region increases risk. A well-diversified portfolio—across countries, sectors, and asset types—offers more consistent performance and better downside protection.

The role of bonds in a portfolio

Q: Isabel also asked about bond ETFs—how do they fit into a portfolio, and what should we consider when choosing them?

A: Bonds form the defensive part of a portfolio. They help reduce volatility and provide income, but not all bonds are the same. Here’s how to think about them:

What kind of bond ETF are you talking about?

There are many types of bond ETFs, each serving different purposes. Some are designed to provide income (through credit exposure), while others are more defensive (through longer duration). The first step is understanding what role the bond is meant to play in your portfolio.

• Understanding duration and credit risk:
  • Duration refers to how long the bond lasts. Longer-duration bonds are more sensitive to interest rate changes but typically offer higher returns.
  • Credit risk refers to the likelihood that the bond issuer might default. Government bonds have low credit risk, while corporate bonds may offer higher yields but come with more risk.
• Why bonds aren’t like term deposits: Bonds are traded daily and can fluctuate in value. They’re not fixed like term deposits. However, they often rise in value when shares fall, offering a “flight to safety” effect.
• How we construct bond portfolios: A well-structured bond portfolio includes:
  • Shorter-duration bonds: These are very stable and ideal for covering short-term expenses.
  • Longer-duration bonds: These offer slightly higher returns while still maintaining capital stability. This mix ensures clients can access funds when needed without selling assets at a loss, while still earning a reasonable return over time.

Q: So, are bonds still worth it in a rising interest rate environment?

A: Yes—especially when used strategically. Shorter-term bonds offer stability, while longer-term bonds can still provide solid returns. The key is balance and understanding how each component supports your overall goals.

Asset allocation

Q: With so many moving parts—growth vs defensive, Australian vs international, bonds vs shares—how should I think about asset allocation as a whole?

A: Asset allocation is the foundation of your investment strategy. It’s not about chasing the best-performing market or asset class—it’s about building a portfolio that supports your goals and can weather different market conditions.

1. Start with the growth vs defensive split

This is the most important decision. Ask yourself:

• When will I need to access this money?
• How much risk am I comfortable with?
• What return do I need to meet my goals?

Your answers will guide how much you allocate to growth assets (like shares) versus defensive assets (like bonds).

2. Build for all weather

You don’t want a portfolio that performs brilliantly 70% of the time but crashes the other 30%. Instead, aim for consistency. That means:

• Diversifying across countries, sectors, and asset types
• Avoiding concentrated bets on trends or regions
• Including both income-generating and growth-oriented investments

3. Stay disciplined

Markets will rise and fall. Parts of your portfolio will underperform at times. That’s normal. The key is to stay the course. As Steve put it, even legendary investors like Warren Buffett don’t try to time markets. The real power lies in sticking with a well-constructed plan.

The biggest takeaway?

A: There’s no perfect portfolio—but there are smart principles. Start with your goals, build a diversified mix of assets, and stay disciplined. That’s how you give yourself the best chance of long-term success.