Re-balance Cycle Reminder All MyPlanIQ’s newsletters are archived here.

For regular SAA and TAA portfolios, the next re-balance will be on Monday, August 15, 2016. You can also find the re-balance calendar for 2016 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.

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

Portfolio Construction Using Stock ETFs And Bond Mutual Funds

It’s no secret that we are very fond of our total return bond fund portfolios (see the fixed income portfolios listed on ‘What We Do -> Brokerage Investors‘ page). We have written various newsletters on these portfolios such as the following: 

These portfolios have done so well: they are consistently outperforming even the best fixed income mutual funds such as PIMCO Total Return Bond, DoubleLine Total Return Bond or Loomis Sayles Bond etc. We believe that when it comes to fixed income (bond) investing, bond ETFs are still not comparable to the best total return bond funds. 

In one of our previous newsletters, September 15, 2014: Equity And Total Return Bond Fund Composite Portfolios, we alluded a way to construct an overall asset allocation portfolio by using a full equity (i.e. risk profile 0 or so called most aggressive) portfolio for equity (stock) part and a total return bond mutual fund portfolio for fixed income (bond) part. In this newsletter, we will discuss this topic in more details. 

First, let’s review the full equity + total return bond mutual fund portfolios. 

Total Return Bond Mutual Fund Portfolios For Fixed Income Investments Boosted Returns

The idea mentioned in the previous newsletter is that regardless whether you are using ETFs or mutual funds as your candidate funds to construct a portfolio, you should always use a total return bond fund portfolio (a mutual fund portfolio) for your fixed income allocation. This is applicable to both  Strategic Asset Allocation (SAA) and Tactical Asset Allocation(TAA) strategy based portfolios. For example, if you choose to invest in Schwab using a TAA (tactical) ETF portfolio, you should only use the ETFs to construct a full equity (i.e. risk profile 0) TAA ETF portfolio (such as a  Schwab Commission Free Core ETF portfolio) and then use Schwab Total Return Bond for the fixed income (bond) allocation. If you decide to use Schwab SAA (strategic) core mutual fund asset allocation portfolios, you still do the same: using a full equity SAA mutual fund portfolio for the equity part while using the Schwab total return bond portfolio for the fixed income part. 

Recent performance of the portfolios mentioned in the newsletter:

Portfolio Performance Comparison (as of 8/8/2016):
Ticker/Portfolio Name YTD
1Yr AR 3Yr AR 5Yr AR 10Yr AR 10Yr Sharpe
60 Percent MyPlanIQ Diversified Core 40 Percent Schwab Total Bonds 9.4% 8% 5.6% 7,4% 11.1% 1.06
MyPlanIQ Diversified Core Allocation ETF Plan Tactical Asset Allocation Moderate 8.7% 6.9% 4.4% 6.3% 8.9% 0.86
60 Percent Six Core Asset SAA 40 Percent Schwab Total Bonds 14.1% 10.4% 7.3% 9.2% 6.9% 0.49
Six Core Asset ETFs Strategic Asset Allocation – Optimal Moderate 7.8% 4.5% 4.7% 7.0% 5.0% 0.33
VBINX (Vanguard Balanced Index Inv) 7.3% 6.0% 7.9% 10.1% 7.0% 0.53

See detailed comparison >>

Again, we are seeing that the mixed portfolios have outperformed consistently in every period listed on the table! This clearly shows that the total return bond fund portfolio has done a consistently better job than using either bond ETFs or bond mutual funds in a plan. The outperformance also clearly shows that the fixed income part makes a big difference on the overall portfolio returns. 

ETFs for stock investing

We can go a step further in the above approach: we just simplify our life such that we will only use index ETFs for stock part investments. Basically, what we argue here is that for stock investments using low cost ETFs is a better approach than using mutual funds in almost all situations. Doing so has several salient advantages:

  • Expenses: ETFs in general have much lower (or sometimes lowest) expense ratios, even compared with the same low cost index mutual funds. For example, the famous Vanguard S&P 500 ETF (VOO) has 0.05% annual expense ratio, compared with 0.17% of Vanguard 500 index fund (investor class) VFINX.  The brokerage core ETFs used in our brokerage ETF portfolios have lower expense ratios compared with core mutual funds used in our brokerage mutual fund portfolios (see What We Do -> Brokerage Investors). Or see the following newsletters for these portfolios:
  • Commission free: most brokerages provide commission free ETFs that are sufficient to build a good asset allocation portfolio. However, the same is not true for trying to find low cost index mutual funds. In fact, many brokerages either have index mutual funds that charge much higher expense or do not provide index mutual funds for some asset classes at all (so you are forced to use more expensive active mutual funds). For example, we mentioned in the previous newsletter that The lowest fee index fund in Merrill Edge is 0.3% (T.Rowe Price Equity Index 500), far more expensive than 0.17% of Vanguard 500 index (VFINX).  Now compared with using VOO in Merrill Edge commission free, we have 0.25% cheaper option!
  • Much wider selection: it’s actually surprising to make such a claim. However, in the process of scouting out low cost index mutual funds for our brokerage core mutual fund portfolios, we are constantly frustrated to find good low cost mutual funds for various sectors/styles (such as dividends, small/mid cap stock funds etc.). For example, one can’t purchase Vanguard index funds from Schwab or Fidelity free of transaction fee. So we were forced to use some active/expensive mutual funds instead. 
  • No minimum holding period restriction for ETFs, compared with the usual 3 month or so minimum holding periods most brokerages/mutual funds impose. This might prove to be more important for stock asset classes which are often more volatile. So, it makes sense to use ETFs for stocks while for bonds, a bit longer holding period proves not making much difference in returns (in fact, often it can yield better returns). 
  • Tax efficient: if you are fond of using a mutual fund portfolio, we would claim that using low cost index ETFs would be more tax efficient. This is especially true for an SAA (strategic) portfolio. On the other hand, for bond investments, their major returns come from interests which are charged as ordinary income in a taxable account anyway. Thus, there isn’t much savings if one uses bond ETFs instead of bond mutual funds. 

To reiterate, bond mutual funds and bond ETFs have comparable tax efficiency while index stock ETFs are more tax efficient than stock mutual funds in general. Putting this, the cost advantage of stock ETFs and the excellent outperformance of total return bond mutual fund portfolios, the ‘best’ combination for a portfolio would be ETFs for stocks and total return bond mutual funds for bonds. 

The above discussion is certainly not applicable to a 401k account that is usually limited to a pre-selected list of funds (usually mutual funds). But even for a tax deferred IRA account, the outperformance of total return bond portfolios becomes the deciding factor to use bond mutual funds instead. 

Finally the above argument can be even extended to a timing based portfolio such as P SMA 200d VFINX Total Return Bond As Cash Monthly. In general, it’s always better to use total return bond fund portfolios for bond investments until more and more active and total return bond ETFs are introduced and become mature for public use.  

Market Overview

As it stands last Friday, with 86% of S&P 500 companies reporting Q2 earnings, the Factset’s blended (actual + expected for the remaining un-reported companies’ earnings) is -3.5% year over year decline. Again, this will mark the fifth consecutive quarter of year over year earnings decline. Just as what we pointed out before, investors are hoping that after quarter (Q2), corporate earnings will recover and grow again. For example, see this new  Schwab commentary. It appears that is what stock markets are hinged on at the moment. Risk is high for a substantial decline in the future. However, we can not exclude the possibility of the next earnings growth investors are hoping for. Again, the best way is to stick to our plan and respond based on strategies. 

For more detailed asset trend scores, please refer to 360° Market Overview

We would like to remind our readers that since the financial crisis in 2008-2009, we have not seen substantial structural change in the U.S., European and emerging market economies. Economies have heavily relied on low interest debts. Capital might be misallocated to unproductive investments and consumption. U.S. stock valuation is at a historically high level. It is thus not a good time to take excessive risk. However, we remain optimistic on U.S. economy in the long term and believe much better investment opportunities will arise in the future. 

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. 

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