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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.
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
(continued on page 2
(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
Current (Last Qtr.)
For Aggressive Risk Investors
Current (Last Qtr.)
For Conservative Risk Investors
Current (Last Qtr.)
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.
Our Specific Fund and Allocation Recommendations Now (vs Last Qtr.)
Recommended Category Weighting Now (vs Last Qtr.)
-Fidelity Low Priced Stock (FLPSX)
Mid-Cap/ Small Cap
-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.)
-Vanguard Growth Index (VIGRX) 7.5 (7.5)
-Fidelity Contra (FCNTX) 7.5 (5)
-Vanguard Equity Inc (VEIPX) 10 (7.5) (M)
-Vanguard US Value (VUVLX) 7.5 (5) (A)
-Vanguard Energy (VGENX) 2.5 (2.5) (A)
A stock or bond fund shown with (C), (M), or (A) indicates it is most suited for Conservative, Moderate, or Aggressive investors, respectively.
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.
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.
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 Recommendations Now (vs Last Qtr.)
Recommended Category Weighting Now (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!)
-DoubleLine Tot Ret Bond I (DBLTX) 10 (7.5), or
-DoubleLine Tot Ret Bond N (DLTNX)
(See Note 2.)
-Vang. Intermed.-Tm Tax-Ex (VWITX) 17.5 (17.5)
(See Note 3.)
Interm. Tm. Muni
-Vanguard Sh. Term Inv. Grade (VFSTX) 10 (10)
-Vanguard GNMA (VFIIX) 5 (0) (New!)
-Vanguard High Yield (VWEHX) 10 (10)
-PIMCO For. Bd (USD-Hdged) Adm (PFRAX) 25 (25)
When possible, select PTTRX; HABDX is only recommended if you cannot meet PTTRX's minimum.
The two funds are the same but have different minimums; select DBLTX if
possible because of lower expense ratio.
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.
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
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]
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
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.
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
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.
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