2016 Tom Madell, Ph.D.

Apr. 2016

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Mutual Fund/ETF Research Newsletter


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To Our Subscribers and Other Readers:

This month, we feature three articles, each of which should be about equally important to concerned fund/ETF investors.

However, in discussing the article beginning on page 5 which concerns not overpaying on your taxes when selling a fund housed in a taxable account with my wife, she opined, and I think correctly so, that most investors will not attempt to reduce their taxes as I recommend.

Why not? Because not knowing how to correctly figure one's capital gain on a sale of a fund, they will just accept the gains figures that are sent by their investment company a few months before tax time. While this is obviously the easiest thing to do, it may not be the wisest as the article points out.

Likewise, figuring out which investment is the most tax-efficient in a taxable account may not exactly be the average investor's cup of tea. However, if one is serious about retaining the most from one's investments as opposed to investing in what might appear to be a perfectly good fund but winding up sending off too much of your hard earned gains to the IRS, they should understand how index funds and some ETFs may soften the blow. Our article "Can Investing in ETFs Reduce Your Tax Bill?" on p. 6 should help clarify things.

Finally, occasionally modifying your fund choices and portfolio allocations can also be a time-consuming and worrisome effort. While many readers may not want to follow our allocation advice, we believe our Newsletters have conclusively demonstrated the long-term gains can far outweigh the effort for those who do.

Best wishes,

Tom Madell, Publisher


-Model Stock and Bond Portfolios for April 2016
  (begins below)

-Alert! Fund Companies Are Telling You
  To Pay Too Much In Taxes (see page 5)

-Can Investing in ETFs Reduce Your Tax Bill?
  (see page 6)

Model Stock and Bond Portfolios for April 2016

By Tom Madell

Every calendar quarter, I re-assess our prior Model Portfolios to see if anything has changed enough to recommend revisions.

For many investors, sometimes myself included, it can be difficult to implement the recommended changes. Switching one's investments around involves some effort and may subject one to a certain amount of anxiety as to whether the decisions will ultimately turn out to have been the correct ones.

Furthermore, if the changes involve selling/exchanging an existing fund within a taxable account, one must weigh the implications for one's taxes - sales may generate additional capital gains tax and even push one into a higher tax bracket. Therefore, it is usually best to try to make the majority of portfolio changes within a tax-deferred account.

Additionally, some investors may hold funds that have exit fees. My advice is to avoid such funds altogether, but if you are already invested in these, it's an additional thing to consider before making changes.

Given these drawbacks, as well as others, I try to keep portfolio changes to a minimum. And, it is another reason I subsequently report portfolio performance assuming at least a one-year holding period, but preferably, at least three.

(continued on page 2 below)

Page 2

Apr. 2016

(Model Stock and Bond Portfolios for April 2016, continued from page 1)

I recognize that many investors may choose not to make the relatively few changes I recommend. In the great majority of cases, most of the funds I have recommended down through the years have usually proven to have good outcomes regardless of how long they were held and whether or not one's allocations to them were altered along the way. But in many cases, the recommended changes would have been highly advantageous in improving portfolio performance results.

I believe that in investing, relatively small changes are the happy middle ground between huge changes vs. hardly ever making any changes at all.

Overall Allocation Recommendations for Stocks, Bonds, and Cash

I see little reason for much change in one's overall allocations at this juncture. I continue to see stocks as generally overvalued, and, while bonds will likely not produce noteworthy returns, they will still be of considerable value in providing a relatively stable anchor for a portfolio as well as offering the potential for marginally better returns than cash.

For Moderate Risk Investors

Asset Current (Last Qtr.)
Stocks 52.5% (52.5%)
Bonds 35 (35)
Cash 12.5 (12.5)

For Aggressive Risk Investors

Asset Current (Last Qtr.)
Stocks 67.5% (67.5%)
Bonds 25 (22.5)
Cash 7.5 (10)

For Conservative Risk Investors

Asset Current (Last Qtr.)
Stocks 20% (20%)
Bonds 50 (50)
Cash 30 (30)

Specific Stock Fund/ETF Recommendations

Our recommended percentage allocation to each stock fund category remains the same as last Quarter's recommendations. However, we have dropped two of our specific, previously recommended funds because we feel they may not perform as well as either the replacement fund we now recommend or the remaining funds within the same category. The reasons for each change are explained following the table starting on the next page.

Page 3

Apr. 2016

Our Specific Fund and Allocation
Recommendations Now (vs Last Qtr.)


(vs Last Qtr.)
-Fidelity Low Priced Stock (FLPSX) 10% (10%)

   Small Cap

    10% (10%)

-Fidelity Overseas (FOSFX) 5 (5) (A)
-Vanguard Europe Index (VEURX) 5 (5) (M)
-Vanguard Pacific Index (VPACX) 10 (10) (A)
-Tweedy Brown Global Val (TBGVX) 5 (5) (C & M)
-Vang. Emerging Markets Idx (VEIEX) 10 (10) (A)
-DFA Internat Small Cap Val I (DISVX) 5 (5) (A)
   (See Notes 1, 2 and 3.)


    40 (40)

-Vanguard Dividend Growth (VDIGX) 7.5 (0) (New!) 
-Vanguard 500 Index (VFINX) 7.5 (7.5)

  Large Blend 

    15 (15)

-Vanguard Growth Index (VIGRX) 7.5 (7.5)
-Fidelity Contra (FCNTX) 7.5 (5)
 Large Growth 
    15 (15)

-Vanguard Equity Inc (VEIPX) 10 (7.5) (M)
-Vanguard US Value (VUVLX) 7.5 (5) (A)


    17.5 (17.5)

-Vanguard Energy (VGENX) 2.5 (2.5) (A)


    2.5 (2.5)

  1. A stock or bond fund shown with (C), (M), or (A) indicates it is most suited for Conservative, Moderate, or Aggressive investors, respectively.
  2. Vanguard ETFs (exchange traded funds) are often practically identical to similarly named Vanguard "Investor" index funds with even lower expense ratios and without the higher minimums required for the "Admiral" funds. Therefore, these ETFs can be substituted for any Vanguard stock or bond index fund shown in tables. E.g. Vanguard FTSE Europe ETF (VGK) can be substituted for VEURX.
  3. Although not included in the Model Portfolio, you may want to consider two other (or additional) international ETFs: WisdomTree Europe Hedged Equity ETF (HEDJ) and WisdomTree Japan Hedged Equity ETF (DXJ). These ETFs, unlike the recommended Vanguard Europe and Pacific funds, tend to do better when the US dollar is strong, as it has been since roughly mid-2011.


We have added Vanguard Dividend Growth (VDIGX), replacing Fidelity Large Cap Stock (FLCSX), which after two years in the Portfolio, has suffered from severe recent underperformance. VDIGX has been an excellent performer, regularly beating the S&P 500 and its Large Blend category competitors over extended periods with its current long-time manager. Even taking into account distributions which reduce after-tax performance, it excels. The main drawbacks appear to be its relatively large exposure to the underperforming Industrials sector and the overvalued Health sector.

We are also eliminating T. Rowe Price Value (TRVLX) because, while the pretax returns have generally been excellent, the after-tax returns have suffered over the last five years due to large distributions.

Page 4

Apr. 2016

You might wonder why we aren't recommending T. Rowe Price Blue Chip Growth Fund (TRBCX) within the Large Growth category, given our positive appraisal in the article beginning on page 6. As discussed in the January Newsletter, we consider the Health sector one of the most overvalued stock fund categories at this time and already for quite a while, doing especially poorly over the last year. Yet this fund has its largest position there. This appears to be why the fund is off to a poor start this year and has been underperforming our currently recommended Large Growth funds with a considerably lower commitment to the category.

Specific Bond Fund/ETF Recommendations

Our Specific Fund
and Allocation
Now (vs Last Qtr.)


(vs Last Qtr.)
-PIMCO Total Return Instit (PTTRX) 15% (25%), or
-Harbor Bond Fund (HABDX) (See Note 1.)
-PIMCO Total Return Active ETF (BOND) 2.5 (5)
-Vanguard Total Bond Market ETF (BND) 5 (0) (New!)


    22.5% (30%)

-DoubleLine Tot Ret Bond I (DBLTX) 10 (7.5), or
-DoubleLine Tot Ret Bond N (DLTNX)
   (See Note 2.)


    10 (7.5)

-Vang. Intermed.-Tm Tax-Ex (VWITX) 17.5 (17.5)
   (See Note 3.)

 Interm. Tm.

    17.5 (17.5)

-Vanguard Sh. Term Inv. Grade (VFSTX) 10 (10)

    10 (10)

-Vanguard GNMA (VFIIX) 5 (0) (New!)

      5 (0)

-Vanguard High Yield (VWEHX) 10 (10)

  High Yield

    10 (10)

-PIMCO For. Bd (USD-Hdged) Adm (PFRAX) 25


    25 (25)


  1. When possible, select PTTRX; HABDX is only recommended if you cannot meet PTTRX's minimum.
  2. The two funds are the same but have different minimums; select DBLTX if possible because of lower expense ratio.
  3. Muni bonds are only suitable for taxable accounts. Invest in a fund with bonds specific to your own state, if available, for the greatest tax savings.


I have been an extremely long-term investor in PIMCO Total Return Instit (PTTRX), allocating a high percentage of our Model Bond Portfolio to the fund. In the past, this has almost always been a boon to our bond results. And my confidence in the fund has been largely unwavered in spite of losing its legendary manager, Bill Gross, in 2014.

However, over the last five years, the fund's performance has been decidedly mediocre in spite of the excellence of its three new managers. Perhaps right now, with the overall bond market unable to get very far since early 2015, there are lesser opportunities within the fund's usual domain of investments. Rather, more specialized types of bond fund categories may now be a better choice.

We will still keep a sizeable portion of the portfolio invested in the fund, together with its, perhaps, more nimble ETF cousin, BOND. However, we are now recommending new positions in the broad index, the Vanguard Total Bond Market ETF (BND), and in the Vanguard GNMA Fund (VFIIX), both available at a significantly lower cost. [End]

Page 5

Apr. 2016

Alert! Fund Companies Are Telling You To Pay Too Much In Taxes

by Tom Madell

This is a follow-up to my March 2014 article entitled "Selling a Fund? Don't Overpay on Your Taxes."

Granted most of you are not very interested in figuring out how much tax you owe when selling a fund from a taxable account. I agree this is a very dreary subject indeed. Most of us would rather just leave this to our tax preparer or tax preparation software. Even if one does their own taxes, mutual fund companies typically will let us know on yearly tax forms how much we profited or lost.

But in my 2014 article, I pointed out how one could be losing a lot of money to taxes if one followed the numbers provided by these easy to use, but usually incorrect sources.

I further researched this topic to bring my thoughts up to date and to check to see if my conclusions were still correct. And according to the IRS instructions to taxpayers, they still are.

This is a subject I haven't seen reported elsewhere. Under certain circumstances one could potentially be overpaying thousands of dollars (although in many cases less) if one does not fully understand why using gain figures reported by fund companies, and even tax preparers or TurboTax (when I last checked), do not accurately reflect your what you could and should be reporting when you sell a fund.

Everything I explained in my 2014 article remains true, so I suggest readers interested in saving money when reporting partial sales from a fund you have owned since before 2012 consult the article before filing any further tax returns involving such sales. (Note: Completely selling out of a fund will not be so affected.)

Why is there this discrepancy which favors the IRS and not you, the fund investor? It appears that in order to "simplify" the reporting requirements, mutual fund companies (and followed by tax preparation software and tax preparers) have been instructed by the IRS to adopt the financial industry "best practice" of selling an investors pre-Jan. 1, 2012 shares first, before your post-Jan. 1, 2012 shares, or oldest shares first. But such a practice is not best for you since you will owe more tax then necessary on this year's return.

Since share prices, especially for stocks, have typically increased by a large amount since that date, anyone who purchased shares after that date likely won't benefit by the higher cost of shares when computing your gain when the fund companies use your pre-Jan. 1, 2012 fund prices first and not your post--Jan. 1, 2012 prices averaged with your older shares.

The correct way to compute your gain, which in these cases is not reported to the IRS and which you yourself are responsible for figuring, is to use both these pre- and post- prices averaged together as is shown in the IRS's own Publication 550 on page 47. In the example shown there, your reported gain might be considerably lower when computed correctly as opposed to selling the oldest shares first.

Why this extra tax burden has not been brought to investors' attention anywhere else aside from my Newsletter is hard to understand; it appears that both fund companies and tax professionals themselves have not wanted to throw light upon the IRS's mandate to fund companies that helps to extract more from investors than the rules state is necessary, or maybe, some merely never realized that this was indeed happening.

Since you yourself are responsible for reporting the correct gains from these sales to the IRS, you should ignore sales gains that are reported incorrectly to you (but are not at all reported to the IRS) and save money by figuring the smaller amount of gains yourself.

Page 6

Apr. 2016

Can Investing in ETFs Reduce Your Tax Bill?

by Tom Madell

Recently, a very long-time reader of this Newsletter posed an interesting question: In choosing a fund for a taxable account, should one lean toward an ETF over a mutual fund with a similar objective? Why? Because of the near absence of long-term capital gain distributions in ETFs resulting less taxes to pay and therefore a better outcome.

For those who might be attuned to the matter of taxes on funds, you will already be aware that most mutual funds distribute dividends as well as short- and long-term capital gains. This means that for each distribution, your tax bill will typically go up. However, if you invest in indexed mutual funds, as opposed to ones that are actively managed, the capital gains, if any, tend to be much less because hardly any investments in the portfolio are being sold in any given year. But, either way, you will still have about the same amount of dividends to pay taxes on. Of course, within a non-taxable account such as a 401(k), none of this is particularly relevant since you only pay tax sometime in the future when you withdraw money.

Most ETFs are really just a type of index fund and so, in general, such ETFs should also tend to have low capital gains distributions as compared to managed funds. So it might appear that one should always pick either index funds or ETFs within their taxable account. But not so fast.

While picking ETFs and index funds does make a lot of sense for investors who wish to minimize their tax bill, one still needs to consider whether such an ETF/index fund is really going to come out ahead in the long run as compared to an excellently managed fund.

Here is an example. Suppose you are able to identify a managed fund with an excellent track record, one that has, over a significant stretch of time, outperformed a particular benchmark index such as the S&P 500. While generally few and far between, there are some funds, guided by excellent long-term managers, who have often shown such market-beating propensities. While not guaranteed of outperforming in any given year, you might still have confidence such a fund will do better than the S&P 500 over the next few years.

One such a fund might be T. Rowe Price Blue Chip Growth (symbol:TRBCX), a fund I came across in a listing of funds that currently have the most assets. With the same fund manager, it has beaten the S&P 500 when held over 15, 10, and 5 year periods.

But even assuming this fund can continue this outperformance, how well has it done when taxes resulting from distributions are taken into account? One can answer this question by referring to morningstar.com under the "Tax" tab after entering the fund's symbol. According to information displayed there, even after maximum bracket yearly taxes are taken out, one would have lost only a little less than 1/2 of 1% to taxes per year (0.41%) on average over the last 5 years for a post-tax total return, that is, tax-adjusted, of 11.31% annualized. This compares favorably to investing in the Vanguard 500 Index Fund, the Vanguard 500 ETF, or even the Vanguard Growth ETF (VUG), which had tax-adjusted ann. returns of 9.33, 9.45, and 10.22% respectively. (Data as of the end of February.)

Clearly, then, one cannot argue that the investor who chose this fund would have been better off by selecting an alternative fund, merely because it was an index fund, or even an ETF.

While the great majority of managed funds will not stack up as well as TRBCX, it goes to show that a good performing managed fund, frequently managed with an eye to keeping long-term capital gains distributions low, can at times be a better choice than either an index fund or an ETF.

Now if we had picked another T. Rowe Price fund for the above example, US Large-Cap Core (TRULX), it would seem we made a good choice as well. It has too has beaten the S&P 500 by a small amount when held over the last 5 years under the same manager, although largely as a result of its performance in 2015.

But this fund, like many managed funds, distributes gains every year, typically many of them long-term capital gains. As a result, over the last 5 years it has lost approximately 1.5% more than its reported pre-tax performance per year when the investor factors in the maximum yearly taxes resulting from these distributions. Thus, the tax-adjusted return now no longer outperforms the return from either the Vanguard 500 Index Fund or the Vanguard 500 ETF.

But getting back specifically to ETFs, it is often true, as mentioned above, that due to how they are structured, there may be very few long-term capital gains distributed to investors as compared to a managed fund, or even an index fund that is not an ETF. So, should an investor pick an ETF solely for this reason?

On paper, this might appear to be true. But, since most broad-based index funds themselves distribute very few long-term capital gains already, there would appear to be little advantage to picking an ETF over an index fund on that basis alone. But when considering more narrowly defined funds such as a sector fund, the ETF might have a clear advantage. That is, while the managed sector fund might have its tax-adjusted return reduced significantly by these distributions, the ETF likely wouldn't.

Page 7

Apr. 2016


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