Re-balance Cycle Reminder

Based on our monthly re-balance calendar, the next re-balance time will be on MondayOctober 15, 2012. You can also find the re-balance calendar of 2012 on ‘Dashboard‘ page once you log in.

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

Also please note that we now list the next re-balance date on every portfolio page.

Tax Efficient Investing

We released our tax, commission performance analysis feature on a portfolio page last week. Many MyPlanIQ users are concerned about tax rate, especially for the tactical asset allocation (TAA) portfolios. This feature tries to help to answer this question. 

Past decade has been extremely nice for investors: since 2003, President Bush signed into law that reduced long term capital gain and qualified dividend tax rate to 15% for most investors. It was extended twice, one in 2005 and one in 2010, scheduled to expire by the end of this year. If nothing is changed, after 2012, qualified dividends will be taxed at the taxpayer’s ordinary income tax rate while long term capital gain will be increased to 20%. 

So, long term capital gain (20% after 2012) is still very meaningfully lower than short term capital gain (taxed at ordinary income tax rate) for people in 28% or higher tax brackets even after 2012. But it will be bad for dividend seekers as dividends will be taxed as ordinary income. 

In the following, we will look at how tax affects total returns for two representative model portfolios for Six Core Asset ETFs plan. 

To use this feature, scroll way down on a portfolio page and click on ‘+ Tax, Commission Performance Analytics‘ button it will reveal the following (see for example, Six Core Asset ETFs SAA Moderate portfolio):

You then can enter ‘Long Term Tax Rate’, ‘Short Term Tax Rate’, Commission Fee (per transaction) etc. Once the parameters are set, click on ‘estimate after-tax/commission performance‘ button to invoke the computation. 

The following table shows the pre and after tax performance for the two representative model portfolios using the following parameters:

  1 Yr 3 Yr 5 Yr 10 Yr Inception
Six Core SAA Pre-Tax 13.3 9.2 3.8 8.1 6.3
Six Core SAA After-Tax 13.3 9.1 3.4 7.9 6
Six Core TAA Pre-Tax 4.4 6.3 7.3 10.1 8.9
Six Core TAA After-Tax 2.5 5.2 6.2 9.3 8.2

 All data are up to 9/24/2012. Inception date is 1/2/2001. 

Notice that on 9/24/2012, all Vanguard ETFs in the portfolios had ex-dividends. Since in our system, we will only update the dividends (re-investing) a couple of days later, the performance quoted as of now is lower than it should have been since today’s (9/24/2012) dividends were not accounted for. We further note that in many MyPlanIQ’s model portfolios, dividends were not completely accounted for in the past 1 year (a fix was just released last week for this bug). 

We make the following comments: 

  • For SAA (Strategic Asset Allocation), the tax effect is minimal. In the past 10 years, tax bite is about 0.2% annually and since inception is about 0.3%. This is expected for a strategy like SAA that has nominal re-balance activities. 
  • For TAA (Tactical Asset Allocation), tax effect is bigger: in the past 10 years, about 0.8% per year and 0.7% since inception. 
  • However, for TAA, last 1 year tax effect is BIG: 1.9%. This is because some accumulated gains (short term) from 1 year ago were realized in the last 12 months and that resulted in a bigger tax bite. 
  • In general, however, TAA’s tax impact is not too bad. Our rule of thumb is about 1-2% annually. Considering its outperformance against SAA, we believe TAA is still beneficial even in a taxable account. We also remind readers of the comment we made on the average number of transactions per year for a TAA portfolio: What is the average number of transactions per year for Six Core Asset ETF TAA Portfolio?
  • Core satellite portfolios we advocate can further mitigate tax impact. By taking tax and risk into account, one can come up with the percentages for core and satellite portfolios. 

In conclusion, intermediate to long term asset trends based tactical asset allocation is not tax efficient for sure. However, it is not terribly inefficient also. Its tax efficiency is good enough to warrant a consideration for taxable accounts. 

Market Overview

Markets continue to stay at the elevated levels, virtually for all of the assets. 10 year or long term treasury bonds recovered somewhat after big drop in the first 2 weeks of September. For now, everything price wise is pointing to risk on direction. However, the underlying economic fundamentals are very uneven and many problems remain unsolved.  

See 360° Market Overview for more asset class trends.

We note that most asset allocation funds monitored on SmartMoneyIQ Managers are maintaining very meaningful and steady exposure in risk assets. One noticeable trend for fixed income bond funds is that well known bond funds such as PIMCO total return bond fund (PTTRX, Bill Gross) PIMCO Total Return (PTTRX)DoubleLine Total Return Bond I (DBLTX)Metropolitan West Total Return Bond (MWTRX) and TCW Total Return Bond (TGLMX) all increased emerging market bond exposure or correlation recently. 

We remain deeply skeptical on this rally. 

We again copy our position statements (from previous newsletters): 

Our position has not changed: We still maintain our cautious attitude to the recent stock market strength. Again, we have not seen any meaningful or substantial structural change in the U.S., European and emerging market economies. However, we will let markets sort this out and will try to take advantage over its irrational behavior if it is possible. 

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot. 

Portfolio Review

We compare the performance of several tactical asset allocation portfolios for brokerage specific mutual fund plans: 

Portfolio Performance Comparison (as of 9/24/2012)

Portfolio/Fund Name 1 Week
1Yr AR 1Yr Sharpe 3Yr AR 3Yr Sharpe 5Yr AR 5Yr Sharpe 10Yr AR 10Yr Sharpe
Schwab Income Mutual Fund Select List Tactical Asset Allocation Moderate -0.5% 7.3% 9.0% 162.4% 11.0% 98.5% 9.0% 94.5% 9.9% 111.4%
Fidelity Extended Fund Picks Tactical Asset Allocation Moderate -0.2% 6.8% 8.1% 100.8% 11.3% 114.2% 12.6% 126.3% 16.2% 165.4%
Schwab OneSource Select List Funds Tactical Asset Allocation Moderate -0.2% 6.7% 7.7% 95.8% 7.7% 62.5% 5.7% 50.7% 11.6% 108.7%
TD Ameritrade Premier List No Transaction Fee Mutual Fund Plan Tactical Asset Allocation Moderate -0.4% 7.4% 8.8% 106.9% 8.6% 78.6% 7.5% 70.0% 14.0% 136.6%
Etrade All Star Funds Tactical Asset Allocation Moderate -0.4% 7.2% 10.1% 182.6% 11.4% 112.0% 11.5% 116.8% 15.1% 152.6%

*: NOT annualized

**YTD: Year to Date

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