Active vs. Passive – Morningstar’s Second Half 2009 Report
Posted on 23. Feb, 2010 by Casey Smith
Morningstar has released their Box Score Report looking at active vs. passive over the second half of 2009. The report uses Alpha to show if a fund manager has beaten its assigned index. For our less analytical readers, an alpha greater than one means the manager beat the index. An alpha less than one indicates the manager is lagging behind the index. In this report alpha is adjusted for risk in order to make fair comparisons.
This report shows that only on third of funds managers had a positive alpha over the last three years. The report also goes on to show that expenses and taxes greatly degrade fund performance. Another interesting note is that active fund managers tend to outperform in poor performing areas of the market, but in “hot” areas they tend not to keep up with the index.
Overall, there is really nothing new, just a reminder that low cost passive investing should have a place in everyone’s portfolio. This report supports the Wiser investment philosophy of maintaining a diversified portfolio, keep cost low and always invest for the long term.
Faith Based ETFs: Investing with Conviction
Posted on 15. Feb, 2010 by Casey Smith
In today’s investing world, many individuals simply choose the assets class (ex. Large cap) they wish to invest in and turn over the company picking to a mutual fund manager or an underlying index through an index fund or Exchange Traded Fund (ETF). However, when choosing individual stocks, an investor has the opportunity to screen out companies that they do not approve of, such as those that sell or promote pornography, alcohol, or gambling. The investor could also screen for a company that is environmentally conscious or encourages corporate responsibility.
Those investors looking to invest in ETFs, but still only desire to support companies within their values can now turn to a company called Faith Shares. Faith Shares has recently launched five new ETFs that invest with Christian values in mind. The company’s product line includes a Catholic Values Fund, Baptist Values Fund, Christian Values Fund, Lutheran Values Fund and the Methodist Values Fund.
All funds are built by selecting the 400 largest US companies. These companies are screened by the fund’s religious values and then ranked by their Environmental, Social, and Governance (ESG) score by industry. The companies are then sorted by industry in a way that mirrors the FTSE US Index. The top 100 stocks will make up the fund, allocated at 1% each. The passively managed portfolios will be rebalanced and could have company changes each June.
This equal weighted approach to investing allows the funds to be non-cap size biased. In comparison, the S&P 500 (SPY) ranks companies by size, thus the investor has a larger portion of the mega size companies. The equaled weighted approach (RSP) has outperformed the traditional S&P 500 weightings 1.54% to 0.41% over the last five years. However, because the equal weighted approach allocates with smaller companies, there is additional risk. The five-year Standard Deviation of the S&P 500 is 16.0 whereas the equal weighted approach is 19.96 (as of 2/12/2010 comparing SPY to RSP as Faith Shares does not have an actual 5 year record).
The funds have virtually the same holdings with a few minor differences. For example, the Baptist funds is restricted to hold alcohol companies while the Catholic fund will. Investing with your values in mind certainly does not come without a price, though. The ETFs currently have an exceptionally high cost of 0.87% in annual management fees. In comparison, the S&P 500 index (SPY) is less than 0.10%. Faith Shares does donate 10% of its funds revenue to a charity and hopes to lower the fee as assets grow.
Faith Shares is also planning a launch of an international product in the near future. Currently, Faith Shares has the only Christian faith based ETF product line on the market. The company’s website nor third party sites show the size of the ETFs, so due to the newness of the funds we assume that the assets in each fund are less than $100 million. This throws up a caution flag. We can see that the daily trading volume of the funds is relatively low, so if you want to trade this ETF, make sure that you use limit orders based on the intra day value of the fund.
With proper trading techniques and a realization that these funds should complement a bigger asset allocation strategy, these funds should fit well with faith-based investors. My biggest issue is the fee. Hopefully with success, Faith Shares will do the right thing and lower the fee below 0.50%. Below 0.20% seems even more reasonable.
The Cruel World of Financial Advice
Posted on 28. Jan, 2010 by Casey Smith
Brokers, commonly called financial advisors, do not give advice! They are not in the business of giving advice-they are in the business of representing products and completing transactions. It’s a mixed up world when your financial advisor is your salesman.
ETFs in your 401k?
Posted on 20. Jan, 2010 by Casey Smith
ETFs are empowering individual and professional investors with the power of transparency, diversification, low fees, and, compared to many of active fund managers, better performance. Exchange Traded Funds allow investors the ability to buy and hold virtually anything. ETFs also allow active traders to move in and out of markets where liquidity, or even access to the market, was virtually non-existent before.
If you’re new to ETFs, the simple way to explain them is to compare them to mutual funds. A mutual fund manager is buying and selling stock throughout the year to try and beat an index, say the S&P 500, which is made up of the 500 largest companies in America. History shows us that fund managers have a hard time doing this over the long term. If you buy an ETF of the S&P 500, you are buying and holding all 500 companies in the index at usually at least 1% less than the mutual fund managers cost.
So now that there are over 900 ETFs to choose from, covering everything from domestic large cap to frontier markets, it leaves one to wonder why these ETFs are not showing up in 401ks. There are several hurdles that 401k providers have to overcome to have ETFs actually inside the 401k plan choices for a participant. One of these is the trading of the ETF. ETFs trade on exchanges just like stocks, so for each transaction there is a cost. This trading cost can quickly erode returns and each transaction could cost as much as $15. For a participant depositing $100 per paycheck into a 401k, this does not make sense. Another issue is the automatic reinvestment of dividends. ETFs do not trade in partial shares like mutual funds. Additionally, for companies like Vanguard, there is really not any reason to offer ETFs in their 401k plans, as their offerings include their index mutual funds at virtually the same cost to the investors.
The good news is that for all the other smaller 401k plans that Vanguard will not work with, these problems have been solved. Companies like Wisdom Tree, Ishares, and a few other smaller players can now bring ETFs to a 401K plan, as well as traditional actively managed mutual funds. Now the issue seems to be education. In many cases, a company’s HR department is the gateway for 401k change. Unfortunately, most HR people seem to be treating ETFs as some form of investing voodoo! This is partially understandable with all the negative press surrounding inverse and leveraged ETFs. If you take a closer look at leveraged and inverse ETFs, you will see that they only make up a small percentage of ETFs, are usually traded by professionals, and can be easily excluded from 401k plans.
The debate as to why ETFs should be in 401k plans could be argued on fund performance. The active vs. passive debate has been covered a lot over the years. The winner is usually a mix of both strategies, although in the interest of full disclosure, my firm uses a buy and hold global indexing approach to investing. This keeps to our investing philosophy of maintaining a diversified portfolio, keeping cost low, and always investing for the long term. Allowing index funds or ETFs into a 401k plan would certainly increase diversification and lower cost dramatically.
The cost of investing is something that is very hard for individual investors to follow. The brokers gloss over the cost of investing. Most that I have met don’t even understand that a mutual fund’s transaction fees aren’t included in the management or 12b-1 fee disclosures. The average mutual fund costs 1.42%. The average iShares ETF costs .41%. The average index mutual fund costs .69%. Since most 401ks have actively managed index mutual funds, in this cost comparison, there is a 1.01% difference in cost between ETFs and mutual funds. If an investor had $20,000 in his or her retirement account and switched to an ETF portfolio, growing at 7% per year for 20 years, paying .50% in fees, the fund would grow to $70,500. If the 401k participant used mutual funds at a fee of 1.5%, the money would only grow to $58,400. This is a 17% difference! Add in the fact that a University of Maryland study showed that only .06% of fund managers beat their assigned index from 1975 to 2007, performance is not even an issue; proper asset allocation and low fees are the key to success.
I don’t believe that rapid change is coming to 401k plans across America, but it could if employees understood what their real cost of investing is, and understood the power of global asset allocation indexing. Certainly if Congress understood how insurance companies and America’s large financial companies are stealing from Main Street 401k plans, we might get change that we could invest in.
Until the day when indexing has its rightful place in 401k plans, there is a work around; a brokerage link. Many 401k plans secretly have the ability to move a portion of a plan participant’s balance into a brokerage account. Through this brokerage account, a participant can invest in individual stocks or… you guessed it… ETFs. Buying individual stocks in your 401k is borderline reckless in my opinion; however a mix of large cap, mid cap, small cap, developed international, small cap international, emerging market, US bonds, US treasuries, international treasuries, and commodity indexes would be incredible. I say brokerage links are secretly available because plan sponsors usually do not advertise this option. Why? Most companies do not want their employees taking their retirement choices into their own hands. I have met a few individuals that I would want to exclude as well, but in a free country, you’re fee to be stupid (or smart, as the case may be). Another reason to do this is the low cost of ETFs. A plan provider such as Merrill Lynch, Fidelity, or JP Morgan receives revenue from the mutual funds that are in the plan. If a participant moves money to a brokerage link and purchases an ETF, the participant will pay a transaction fee to the plan provider; however if the participant uses a buy and hold strategy, the plan provider will not receive any more revenue.
I recently worked with the Atlantic Southeast Airlines Airline Pilots Association (ASA ALPA) on how to get more index mutual funds within the group’s 401k plan. Despite the company’s fiduciary responsibility to look out for the best interest of the plan participants, the company continues to allow their plan provider, JP Morgan, to fill the 401k with proprietary funds like a Morgan Stanley mid cap that has not been in the top 50% of its peers in the last 5 years. The company fails to understand the concept of indexing, asset allocation, and probably standard deviation and the Sharpe ratio as well. These are things that someone who selects a 401k plan should know. ASA ALPA is in a unique situation in that the company wants a new pilot bidding system. In return the pilots get a list of things, including a brokerage link. Finally, the employees of ASA can buy and hold the ETF, thus saving them thousands in management fees. Well and good, you would think, but JP Morgan has just put into place a new brokerage link policy that does not allow ETFs to be held in 401k plans. Why? Of course no rightly minded JP Morgan call center employee would go on the record, but let’s look at the facts.
In 2008, when billions were flowing out of mutual funds, ETFs saw record inflows, gaining assets from the mutual fund business. There are over 900 ETFs on the market offering diversification in virtually any global asset class, many at less than 0.25% a year in fees. Who loses here? Well, besides the fund companies, plan providers such as JP Morgan will lose. In this case I believe that the company (ASA) has the ability to say “Give it to us or we’re moving to one of the other providers (all of them) that do,” and the case will be closed. The pilots have the ability to motivate the company to do this by simply stating, “No ETFs, no new bidding system.” After all, we could be looking at a 17% difference in fund performance at retirement. That is a pay raise they, and the rest of America, cannot afford to give up.
We have now come full circle here, and I believe that it all comes back to education. An educated investor, armed with the understanding that no one is responsible for their financial freedom other than themselves, will be a successful investor.
Now go out, diversify, keep your cost low, and always invest for the long term.
Casey is the principal of Wiser Wealth Management, Inc., and has spoken around the world about ETFs and passive index investing, including the recent Inside ETF Conference in Boca Raton, FL. He is also a pilot for Atlantic Southeast Airlines and works with ASA ALPA’s retirement committee but in no way represents the committee, ASA pilots, JP Morgan or the ASA, the company. This article was written for www.ETFmarketpro.com.
My Boca Experience – Inside ETF Conference 2010
Posted on 20. Jan, 2010 by Casey Smith
I was recently privileged to be on a panel at the Inside ETF Conference in Boca Raton, FL last week. The event was a great success with over 800 attendees, and was broadcasted live by CNBC. My panel covered how we use ETFs in our practice and how we explain them to our clients. Matt Hougan of ETFR Newsletter and Indexuniverse.com sent me these questions to help me prepare for the event. I thought I would share them with you.
What is your strategy and why do you use ETFs?
Matt, there are three ways to invest. You can buy a stock, buy a mutual fund, or invest directly into indexes (ETFs). The easiest way for me to explain this is if you purchased Coke stock and the evil people at Pepsi poisoned the Coke syrup, causing people around the world to die from Coke, your investment would be worth 0! This is called company risk. While everyone one tells you about their Google-type investment success story, many fail to mention the Enron type losses. The next way to invest would be through a mutual fund. While there are certainly some outstanding fund managers out there, the industry as a whole has had a hard time keeping up with the indexes over long periods of time. If you hired a fund manager to pick your next cola investments, you are beting on his or her ability to avoid the Coke scenario I just mentioned. A less expensive, more transparent, more liquid, and better diversified choice is investing directly into the index using an Exchange Traded Fund. This is like buying all the cola companies out there, which greatly reduces your company and manager risk. Our advisory fee plus the .25% cost of the ETF portfolio is over 1% cheaper than where you are today. In real world terms, Wiser Wealth will purchases ETFs like the SPY that actually purchases all the companies in the S&P 500. The same applies to TIPs, corporate bonds, small cap international, emerging market bonds, and stocks.
Wiser builds portfolios using mostly ETFs like the ones I just described to access various types of indexes around the world. Our core investing philosophy is to maintain a diversified portfolio, keep cost low, and always invest for the long term. We consider ourselves passive indexers with a buy and hold strategy. However, each year we review our models to see if there is a need for rebalancing. While our overall strategy is to buy and hold long term healthy assets classes, we essentially rebuild our 4 main models each summer. While most of the indexes and allocations remains intact, this forces us to look to see if there is access to new ETFs/indexes/asset classes that will help us achieve a portfolio’s objective. We build our portfolios in two ways. Our aggressive model strives to achieve the maximum amount of gain for the least amount of risk. All other models, such as conservative through moderate, strive to achieve the maximum amount of gain for a given amount of risk. Here are some examples……………. Let’s compare the cost and performance of these models to where you are now.
What are the risks of ETFs that you’re not telling me about? What could go wrong?
The ETFs that we trade in are large, proven investments that have been around for a long time. There are ETFs that use leverage or investing formulas that are not very clear. These ETFs have additional risks. We do use a commodity ETN that gives you the returns of a commodity index; however, you do not actually own any commodities. What you own is a promise to pay the index’s returns. Should the provider go out of business, you could lose your investment in that ETN. We monitor the financial health of the issuer in this case. For example, when Lehman began having issues, we looked closely at the health of Barclays.
Why not use index mutual funds?
Wiser uses a complete indexing approach. We do not seek out actively managed mutual funds, as they generally are more expensive than indexing. We do not believe that timing the market has proven successful. There are index mutual funds that work for individual investors, but at our custodian, trading an ETF costs half as much as trading an index mutual fund. Index mutual funds do have some tax disadvantages compared to ETFs and, for the individual investor, index mutual funds are more expensive.
I’ve heard commodity ETFs don’t actually deliver the spot returns you expect. Why is that?
The way commodities get represented in commodity indexes and inside ETFs are typically through rolling futures contracts. Returns from these contracts come from the change in the expected future price of the commodity; this price is very different from the actual price of the commodity that can be bought today, which is the spot price.
Many investors were surprised this year when the oil fund they thought was tracking oil prices was actually tracking the expected future price of oil.
Why should I pay an advisor to manage a passive investment strategy? Can’t I do it myself?
For many investors, asset allocation is built on feeling rather than using standard deviation, the Sharpe ratio, and other types of risk measuring tools. Will you rebalance your portfolio on your own? Will you be able to understand economic events and how to adjust the portfolio accordingly? Do you ever have tax questions or estate planning questions? Our AUM fee covers not just portfolio management, but also tax and estate planning. These are the questions that I would ask a do-it-yourself investor. You have to take the emotion out of investing. Many individuals have a hard time doing this, which is why at my firm, we manage by committee.
If you really want to invest on your own through a company like Vanguard, you do have the option to hire us by the hour. However, it is usually cheaper to become a full service cleint.
How do you ensure you get good trade executions?
Most trades at Wiser Wealth are done through batch trades. Batch trades allows us to pull all the investors’ trades together. We then set limit prices on the ETF buys and sells. Our limit prices are based on the NAV of the ETF at that moment of trading. A simple way to get the real time NAV is through Yahoo finance. Just add ^iv to most ETF symbols. A Bloomberg terminal is the other way to get NAV.
What about currency?
We do not invest in currency as an asset class, but some of our indexes, like IGOV and EFA, have benefited from a falling dollar. Last summer, we added TIPS to the portfolio while they were cheap, as no one was talking about inflation. Currency ETFs are trading on currency futures, not actually buying the foreign currency. This has additional risk in an abnormal market. Long term investing in currency is not somehting that we see as healthy at this time.
I read about all the blowups in the leveraged ETFs. How do I know who to trust? Would you use leverage ETFs in your account? What’s wrong with them anyway?
There is nothing wrong with leveraged ETFs IF you understand them. We do not use leveraged ETFs.
I just don’t want my portfolio to go down 50%. What can you do to help me?
For all our models other than the aggressive model, a loss of that magnitude is virtually impossible. However, if losses are not an option, we can employ an option strategy on the S&P 500 to add income and create short term insurance on a portion of the portfolio.
Should I buy an ETN?
Yes, but carefully and probably only for commodity exposure.
I’ve read that you can only buy ETFs with $100 million in assets. Is that true?
That is a good point, but there are 250 ETFs with less than $20 million in assets. You can buy them, but if not traded carefully, you may end up purchasing at a premium. Only one of our ETFs, IGOV, approaches that asset level, with $134M in assets. We noticed when we added IGOV during our last rebalance that it took much longer to purchase at our limit price near the NAV vs. the quick trade at market. The performance has been just fine, it just took a few extra hours to move the trade through. Should it have taken longer, we would have simply called the TD Ameritrade trading desk to call the exchange to get the trade processed.
Indexing Inspiration + Gold
Posted on 17. Dec, 2009 by Casey Smith
Every now and then you read something and you imediately think, “thats what I have been trying to say”. Our friends at Indexuniverse.com have great commentary about indexing and ETFs, but today Kent Grealish in his post “The Making of an Indexer” hit a home run. He said what we often rant about here at Wiser Wealth, but brings it all together with great style! Please take a few moments to read “The Making of an Indexer.” You will once again see why Wiser Wealth uses all ETF portfolio’s and takes an indexers view of the market. Enjoy!
As a bonus here is a great link concerning the recent run up and fall of GOLD prices!!
Fiduciary and the “B”
Posted on 17. Dec, 2009 by Casey Smith
Mutual funds are now closing ‘B’ shares left and right, leaving one to ponder if this is because of demand for fiduciary responsibility in the financial marketplace.
Salespersons, often disguised as “financial advisors,” sell mutual funds for a commission. What many people don’t know is that the mutual fund industry organizes how these salespeople can receive their commission. There are primarily three types of sales loads for a mutual fund; A, B, and C. All of these give the client access to the same manager and portfolio.
‘A’ shares are the most common type. When a client chooses these, he or she will pay upwards of 5.75% of their initial investment in commission. On top of that, the client will also pay an annual 12b-1 fee and management fee, usually greater than 1%, just for holding the mutual fund. This means that the salesperson will receive the bulk of their commission at the beginning of the sale, followed by a smaller amount each quarter. The ‘C’ share of a mutual fund does not have an upfront sales commission, but carries a higher annual management fee. The ‘C’ share offers the salesperson the highest quarterly payout.
The ‘B’ share of a mutual fund is often referred to as the back-end load fund. This term is used because there is no fee charged for the client’s initial investment, but if the client wants out over the next 5 to 7 years, a penalty fee is assessed. The salesperson in this case may still receive the bulk of the commission upfront from the fund company, so the back-end fee is placed in order to make sure that the company can recoup their commission payment. The ‘B’ fund also carries an annual management and 12b-1 fee, usually more than the ‘A’ share, and equal to a ‘C.’ If the client holds the ‘B’ share for the 5 – 7 year period, it will convert to an ‘A’ share.
In 2000, Morningstar reported that ‘B’ share mutual funds made up 7% of mutual funds offered. 9 years later, this number has dropped to only 1%. The Wall Street Journal (WSJ) recently reported that Goldman Sachs, Allianz, and American Century have all exited the ‘B’ share market, citing low client demand.
According to Larry Light of the WSJ, ‘B’ shares were created to compete with the no-load mutual funds offered by Vanguard and T. Rowe Price in the late 80’s. No-load funds do not have any upfront fees and comparatively low annual fees. Mr. Light’s WSJ article also states that the brokerage firms are tight lipped about why they are getting out of the ‘B’ share market.
At the beginning of the article, I mentioned the term financial advisor using quotations. This was to help explain the difference between the two current standards for financial advisors. The brokerage houses (Edward Jones, AG Edwards, Morgan Stanley, etc.) are not held liable if they sell the client a product that isn’t in his or her best interest. The client only has to be ’suitable’ for the investment. (For more information about what this means, follow the link). On the other hand, an Independent Advisor is required to put the client’s interest first. This is called fiduciary responsibility. The Obama Administration believes that every advisor should be held to a fiduciary standard. On this point, I agree with the President (for once). Brokerage houses are fighting this fiduciary standard because when they look at the bulk of their “tool box,” they see that this requirement would wipe out their under performing overpriced products.
So is the “lack of demand” for the ‘B’ product because brokers are cleaning up their act and ditching one terrible product to show that they really don’t need to be fiduciaries to have the client’s best interest at heart? And so they can shill other overpriced products instead? Or, are investors wising up and letting “advisors” know that these are bad investments?
In my opinion, ‘B’ shares were never really good investments. In fact, the regulators capped the maximum that could be placed in a ‘B’ fund at $50,000. They probably wanted to do away with them completely, but, as things often go, the big brokerage lobbyists worked a compromise to keep these unfair investments alive.
Closet Indexer
Posted on 08. Dec, 2009 by Casey Smith
This entry was written for www.etfmarketpro.com
For many, the benefits of creating a long term diversified index portfolio are well known. In fact the emergence of ETFs, with their easy access to small cap international, emerging markets, commodities, foreign currency, and many other hard to reach asset classes, has helped passive indexers achieve more diversification and many index professionals achieve higher returns. I have seen a resurgence this past year in the active versus passive debate, due to the S&P 500 having a negative 10 year track record. On our news media outlets, the defenders of passive investing always seem to refer to the dilemma of buying and holding individual securities vs. actively trading securities. However, there is also a debate on whether to buy and hold index funds or buy and hold mutual funds. Active fund managers want you to believe that they can always time the market’s ups and downs and that, for the most part, they will pick winning stocks. This is absurd, of course, but many individual investors, confused by all the debate and different investing schools of thought, fall for the sizzle of short term performance without thinking of long term results.
There is an old joke that financial news journalists write about the hot stock or mutual fund by day and privately invest in long term healthy index funds by night. Could this be true of active fund managers as well? This is where the term “closet indexer” comes from. A closet indexer is a fund manager that mimics the index, or benchmark, that he or she is assigned to outperform. For example, if a fund manager has the same holdings as the S&P 500, thus the same performance, the manager would be a closet indexer. The problem here is that the investor is probably paying 50bps (0.50%) or more for the performance, and thus would have been better off buying the S&P 500 index, SPY, or the Vanguard S&P500 index mutual fund equivalent with fees less than 1/10 of a percent.
Job security and fund size are two major reasons why a fund manager would mimic its assigned index. Fund managers have their performance measured quarterly, so they do not want to stray too far from their assigned index. While they may take additional risk at times to attempt to make up for their fees or try to outperform the market, the overall portfolio is invested in the same sector percentages as the index. The idea is that fund investors would not pull their money out for poor performance if the fund manager performed near the index or his or her peers.
The size of the mutual fund may also push the manager towards being a closet indexer, since only so much can be invested in companies that the manager sees as outperforming the market. The remainder of the fund’s assets are then invested in securities that match the index so that overall performance versus the index will not go awry.
Closet indexers are fairly easy to spot. The most common way to find one is to take the R Squared of the fund. R Squared is a statistical measure that represents the percentage of a fund or security’s movements that can be explained by movements in a benchmark index. For example if a fund has an R Squared of 97, then 97% of its movements matched that of its assigned index.
A search within Morningstar’s database of 24,900 open ended mutual funds for a 10 year R Squared greater than 96 and fees greater than 0.50% found 742 funds. In most cases, an ETF should not cost you more than 35bps (0.35%), but I gave the fund managers the benefit of the doubt by searching for management fees greater than 50bps (0.50%). This means that 3% of all open ended mutual funds perform no better than their assigned index over a ten year period and cost double what they should.
When I dropped the R Squared to 95 or greater, 1,723 funds were returned, making 7% of open ended mutual funds subject to our closet indexer title. I then looked for an R Squared of 97 or greater over the last 12 months with a management fee greater than 0.50%, and the return increased greatly. 5,377 funds were returned, making 22% no better than the index itself.
As you look at your mutual fund, you have to take into account the cost of active management. Maybe your manager beats the market by a few percentage points, but what kind of fees do you have to pay for this performance? Is the net performance near the index returns? Is your fund manager a closet indexer?
This New Year, you should resolve to consider putting your portfolio on a diet and look at the benefits of low cost Exchange Traded Funds (ETFs).
House Makes Death Tax Permanent Today
Posted on 03. Dec, 2009 by Casey Smith
Despite Republican efforts to do away with the Death Tax, the House voted to pass H.R. 4154 with a final vote of 225 to 200. H.R. 4151 will extend the 2009 3.5 million personal exemption (7.0 million per couple) and the 45% tax rate above those levels through 2010. The bill now moves on to the Senate where it is expected to pass. Should nothing be changed, in 2010 there will not be a death tax.
The death tax has always been a hot topic as many believe that this money has already been taxed and should be left alone. Others see the dead as easy targets to generate tax revenues for their favorite government projects.
You should always do financial planning on current laws versus what might be. In this case it appears that the tax is not going away.
Casey T Smith, Master of Estate Preservation (MEP)
Indexing Thought Brought to you by Todays Mail
Posted on 30. Nov, 2009 by Casey Smith
My wife is taking a sabbatical from the duties of a stay at home Mom. She decided to go back to work as a teacher at the request of her former employer during the month of December. I guess she understandably needed a job with less stress than watching our four and two year old. This has left me with the responsibility of the Wiser office, my flying duties at Atlantic Southeast Airlines, car pool at our kids preschool and of course, getting the mail.
Today was my first day on the job as stay at home Dad. Well, we did not really stay home; since the kids were in school, I got a half day in at the office and by the time I got the kids home at 1:30, our two year old was trying to climb into her crib as she was telling me “nite nite” and our four year old was equally sleepy. So, my work continued while they slept. Later, Banks, our English Springer Spaniel, informed me that the mailman had arrived and that I must act immediately. This also meant that my wife may soon be home and my first day as king of the house might end with no screaming, crying orbroken bones and the house left in better condition than when she departed at 6am this morning. Only 14 days left!
As I sorted through the mail, I noticed a post card advertising “401K Maximizer.” This caught my eye since most 401k plans are loaded with unnecessary fees, underperforming fund managers, and are usually the most under advised assets in the industry (from a participant perspective). To even further my curiosity, it was geared only toward airline employees, the most under paid and overworked population outside of stay at home moms and dads, teachers, and a few others.
This 401K Maximizer appears to only be available to those employed by Southwest, Northwest and American Airlines. The service chooses the best (we would say the least worst) mutual fund available in the 401K plan for that particular airline each month according to a conservative, moderate and aggressive risk strategy. The service also will measure the risk of the market and move out of the market based on certain indications. This requires a subscriber to make monthly allocation changes to their 401k.
The website boasts significant returns vs. the S&P 500 since 2001, using an investment method described as “actively upgrading” and declaring passive investing “Buy and hold asset allocation is a recipe for under performance.” For example, the subscription service shows $1,000 invested in 1998 using their service now worth $5,000 vs. the S&P 500 worth just over $1,300. We must note here that back testing must have been used since a quick search on the website shows this as a relatively new product.
Citing the University of Maryland’s Study on the long term performance of mutual funds managers, where only .06% actually beat their assigned index, and recent reports from Morningstar showing that even short term performance leaves little to be desired, we certainly would like to see another strategy used in 401k’s other than active mutual fund management and buying and the holding of underperforming mutual funds. However, I am very skeptical that any market timing monthly trading model can hold up over a long term investment time horizon. If this is indeed it, then it would fall into the .06% of managers that can beat the market over the long term. Actually, they are not really managers, but managers of mutual funds, which would make them active traders of actively trading fund managers!
Buying and holding 12 Exchange Traded Funds in asset classes such as commodities, emerging markets, foreign treasuries, emerging market bonds and other traditional long term healthy asset classes, an investor can easily beat the S&P 500 with much less risk. This buy and hold passive approach with a investing cost less than 25bps (0.25%) has a much higher probability of long term success and is much cheaper than active investing.
To avoid repeating myself, I will refer you to my recent entry on indexing HERE.
To those of you eager to make monthly changes to your 401K plan I urge you to do four things first.
- If you have access to a brokerage link within your 401k, invest using ETFs vs. the mutual funds within your plan.
- If no brokerage link is available, then email your HR Benefits department and request that a brokerage link be added in order to access lower cost, better performing ETFs. You can also request that Index Funds be added to your plan, or if you are really shooting for the moon, ask for a Vanguard 401k plan.
- Resist the urge to day trade your retirement. Open a brokerage account with money you can lose and experiment with that rather than your life’s savings.
- If I still can’t convince you, then read the disclosure page on the 401 Maximizer website:
“The publisher does not analyze the suitability of any particular fund or investment approach for individual investors nor make specific recommendations tailored for individual investors. These portfolios have significant risk and are for the sophisticated investor willing and able to assume a high degree of risk. It is up to the investor to decide their risk level and investment method. Model performance results may have inherent limitations, some of which are as follows. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently significant differences between hypothetical performance results subsequently achieved by following a particular strategy. There are numerous other factors related to the markets in general or the implementation of any specific trading strategy which cannot be fully accounted for in the preparation of model performance results and all of which can adversely affect actual trading results. This material has been prepared or is distributed solely for informational purposes. Past performance is no guarantee of future results. Further, 401k Maximizer, Inc. does not accept any responsibility for gains for losses an individual may experience. All trading is done at your own risk”.
I certainly welcome a new approach to 401k management, but I believe that it is through employer sponsored education on investing and a passive approach using index funds. I will acknowledge that the 401k Maximizer approach may achieve superior short term results, but the higher probability of success lies in the less flashy, more boring buy and hold approach. We also have the data to prove it!!!
Keep your investing cost low, maintain a diversified portfolio, and always invest for the long term.
