Commentary

Posted on

The biggest ETF may be changing

The largest and oldest ETF is the SPDR S&P 500 ETF Trust (ticker: SPY), with $624 B in assets under management. However, two other S&P 500 ETFs are close behind. The Vanguard S&P 500 ETF (ticker: VOO) and iShares Core S&P 500 ETF (ticker: IVV) have $588 B and $582 B of assets under management. In this post, we discuss the likely change in the largest ETF, what may be contributing to it, and why it matters to investors.

In this post, we discuss the likely change in the largest ETF, what may be contributing to it, and why it matters to investors.
Photo by Markus Winkler on Pexels.com

The oldest ETF, SPY

The SPDR S&P 500 ETF Trust, commonly referred to as SPY, has been around the longest of any ETF. With an inception date of January 1993, SPY created an entirely new way to invest in a passive index that offered greater tax efficiency than mutual funds. As we wrote about a few years ago, the taxable gains between ETFs and mutual funds can be significant. This tax inefficiency makes no difference for Individual Retirement Accounts (IRAs). But for taxable account holders, significant tax drag is drawing investors into ETFs. Several mutual funds are converting to ETFs.

The two other S&P 500 index ETFs

ETFs from Vanguard and iShares also offer ETFs that track the S&P 500 index. This index is very popular with many investors as it diversifies across many equity sectors. But, because of its weighting by market capitalization, some companies hold more significant influence. Nevertheless, it remains a popular index for investors. And, with an expense ratio of 0.03%, these ETFs offer this exposure with very little cost. These expense ratios are in stark contrast to SPY, with its expense ratio of 0.09%. While still small, the expense ratio of SPY is 3X larger, helping VOO and IVV to grow faster than SPY.

Another driver of ETF growth

So, investors seem to be preferring lower expense ratio ETFs. VOO’s unique structure may also be contributing to its popularity. But, this benefit, which Vanguard patented, has expired in 2023. So, IVV and VOO may continue to grow at a similar rate. For individual investors, the small difference between the two ETF structures likely makes little difference in meeting their investment objectives.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in tax-efficient investing with ETFs
Posted on

Catch-up contributions to retirement plans

The IRS recently changed retirement savings plans, like 401(k) plans offered by many employers, for workers nearing retirement. Previously, workers 50 and over could make catch-up contributions. Starting in 2025, employees between 60 and 63 can increase these catch-up contributions by an additional 14%, according to this WSJ article. In this post, we discuss why many workers may want to take advantage of this new rule.

401(k) plan contributions

Employee contributions to 401(k) plans were originally established to encourage growing a nest egg for retirement. By contributing pre-tax income, workers could also reduce their current-year taxable income. For older workers who were unable to save earlier in their careers, these catch-up contributions can help retirees meet their savings goals. Also, as many workers enter their 50s, their income often peaks. So, the deferred taxes on 401(k) contributions may provide an added benefit if income is lower in retirement.

Retirement plan catch-up contributions change for 2025.
Retirement plan catch-up contributions change for 2025

Pre-tax or after-tax contributions to a 401(k)

Workers may also have an option in their retirement plan to contribute to a Roth 401(k) plan using after-tax contributions. While these contributions don’t provide the immediate tax deferral of the traditional 401(k) contribution, they do provide tax-free retirement income. Roth 401(k) contributions also help workers save after-tax dollars and avoid the income limit for direct contributions to a Roth IRA. To make a full Roth IRA contribution in 2024, single filers modified adjusted gross income (MAGI) must be under $146,000, and joint filers under $230,000. Alternatively, some workers and retirees may consider a Roth conversion. For large emergency expenses that may occur during retirement, such as medical-related expenses, retirees can use after-tax retirement savings in Roth accounts to avoid higher tax brackets.

Not sure what to do next with your catch-up contributions?

We offer a free simulator to see if you can reach your retirement savings goal.

Retirement plan catch-up contributions change for 2025.
Our free savings calculator simulates future market conditions to assess saving goals

You can use this tool to see how pre-tax or after-tax contributions may affect your future retirement savings. We hope you find this tool educational!

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in tax-efficient investing with ETFs
Posted on

Business leaders are cautious

Business leaders and other corporate insiders aren’t as optimistic as others who are contributing to strong market returns for 2024. Also, according to InsiderSentiment.com, their index continues to track below the long-term average. So, this post examines other possible contributors to lower optimism among business leaders, like Warren Buffett, Jamie Dimon, and Jeff Bezos.

business leaders have low sentiment
Photo by energepic.com on Pexels.com

The fourth year of a presidential cycle

As we’ve written about previously, the four years of a presidential cycle can have very different market returns. So here, we’ve updated the table below from this previous article, and included the upper and lower 95% confidence limits.

Presidential YearAverage Return (%)95% Lower Limit (%)95% Upper Limit (%)
16.7-2.115.6
23.3-4.911.5
314.06.621.5
46.70.612.9
Average Returns of the S&P 500 from 1928 to 2024. Data Source: www.macrotrends.net

So far, with the S&P 500 up about 21% this year, we are well above the upper limit for the 4th year of the Biden administration. Consequently, this statistical analysis suggests markets may trend back to their long-term mean.

Other factors at play for investors and business leaders

Of course, there have been other factors influencing investors recently. For instance, the Federal Reserve recently reduced short-term interest rates by 0.5%. Also, the monthly jobs report was stronger than expected. Lastly, seasonal hiring appears to be picking up ahead of a potentially strong demand this holiday season. Whether these factors hold until the end of the year is uncertain. And, many expect the presidential election result may also impact future market performance, along with whether the port workers strike again in the early part of 2025. Thus, only time will tell how the market responds to these factors of uncertainty.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in tax-efficient investing with ETFs
Posted on

When a Roth Conversion May Be Right for You

A Roth conversion typically moves pre-tax funds from an Individual Retirement Account (IRA) to a Roth IRA. Doing so adds income to the year when account holders convert, so may trigger additional income taxes. But, future withdrawals from the Roth IRA should be tax-free. We’ve discussed some research on this topic before in our article published in the Financial Planning Review. Ed McQuarrie, Emeritus Professor from Santa Clara University just published another article on the topic. It now appears on page 76 in the September 2024 edition of the Journal of Financial Planning. This post will highlight the key findings in this important research related to retirement income and estate planning. We also highlight how our retirement income calculator aligns with these insights for a retiree’s particular scenario.

Roth conversion article by Ed McQuarrie entitled "Net Present Value Analysis of Roth Conversions"

New research contribution

Prof. McQuarrie’s research focuses on the Roth conversion’s Net Present Value (NPV). NPV is an important metric used to value projects, which states that discounted future cash flows must sum to a positive number to add value to the project’s owner. His journal article highlights when NPV turns positive based on the time since the conversion occurred,

Figure 2 from Net Present Value Analysis of Roth Conversions by E. McQuarrie, Journal of Financial Planning, Sep 2024.
Figure 2 from Net Present Value Analysis of Roth Conversions by E. McQuarrie, Journal of Financial Planning, Sep 2024.

As Figure 2 demonstrates, a positive NPV occurs when the retiree reaches age 86. More or less favorable assumptions about future tax rates can decrease or increase the time for NPV to turn positive, and this article highlights a few insightful examples.

Risks in future tax code and individual circumstances

The article continues by discussing several risks faced by a Roth conversion. For example, since the U.S. Congress sets tax laws, taxpayers will never know for certain what income tax rates may be in the future. The Tax Cut and Jobs Act (TCJA) that expires in 2025 may or may not be extended or modified in ways that are favorable to a Roth conversion today. Also, consideration of an heir’s tax rate is important for retirees who have excess funds they wish to pass on after their death. Heirs at lower tax brackets, and certainly heirs who are charitable organizations who may not owe tax on IRA bequests, may benefit more financially in receiving assets from an IRA rather than a Roth IRA. Conversely, a surviving spouse utilizing the standard deduction could significantly benefit from a conversion before the passing of their spouse.

How to assess a Roth conversion for your situation

Given all these complexities, a thoughtful analysis is important before making a Roth conversion. One approach is to use software, like our Retirement Income Calculator. And, given this latest research, there are many nuances to consider before conducting a Roth conversion. This research article nicely highlights four scenarios when a conversion is the least risky and four scenarios when they are most risky and is worthy of review for anyone considering a Roth conversion in the coming years.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in tax-efficient investing with ETFs

Posted on

Stock and bond ETFs reverse recent trends

Economic data on the rising unemployment rate and corporate missed earnings appear to have contributed to the recent reverse of the upward trend in stock ETFs. This post explores this and other recent trends by highlighting selected ETFs that passively track major stock and bond indices.

NASDAQ market correction

As this WSJ article recently highlighted, the NASDAQ (ticker: QQQ) is officially in “correction” territory now. We define a correction as when prices drop by more than 10% from a recent high. Missed expectations from major investments in Artificial Intelligence by tech leaders Microsoft and Alphabet may have contributed. Nevertheless, the S&P 500 index ETF (ticker: IVV) is still up over 12% year to date, as the chart below illustrates. While returns for these two stock ETFs are lower than their mid-year peak, they are still good relative to other markets, like bonds.

Recent trends in stock and bonds ETFs.
Stock ETFs recently started a downward trend, but bond ETFs started an upward trend.

Recent trends in Bond ETFs

Investors appear to be quickly moving away from stock ETFs and into bond ETFs. This so-called “flight to safety” is clear in the image above in the recent upward trends in bond ETFs. The intermediate-term bond ETF, iShares Core U.S. Aggregate Bond ETF(ticker: AGG), shows some of this new trend. This trend is amplified when a longer-term bond ETF, like iShares 20+ Year Treasury Bond ETF (ticker: TLT), is viewed.

What is next?

The Fed left short-term interest rates unchanged after meeting this past week. But, a rate cut is looking more likely, as inflation is down to 2.5% now, edging closer to the Fed’s target of 2%. The Fed’s next meeting is in September, so investors will be eagerly awaiting the outcome of this important meeting. In the meantime, investors may continue to invest in bond ETFs to potentially hedge any additional losses in stock ETFs.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in tax-efficient investing with ETFs
Posted on

2024 Mid-Year Review of Stock-Based ETFs

Welcome to our 2024 mid-year review of stock-based ETFs. Like our previous mid-year reviews, we will discuss here how various sectors of the market performed in the last six months using ETFs. Consequently, we will show a significant performance difference between various sectors of the S&P 500.

Review of the 11 Sectors of the S&P 500

To review, recall that there are 11 sectors in the S&P 500 as shown below. So, while some of these sectors have several ETFs tracking them, we choose the ETFs in parentheses due to their long history in the markets.

  • Information Technology (XLK)
  • Health Care (XLV)
  • Financials (XLF)
  • Consumer Discretionary (XLY)
  • Communication Services (XTL)
  • Industrials (XLI)
  • Consumer Staples (XLP)
  • Energy (XLE)
  • Utilities (XLU)
  • Real Estate (IYR)
  • Materials (XLB)

Then, using this list and reinvesting dividends, we see that some sectors had total returns that did very well in the first half of 2024. However, a couple sectors, such as the Real Estate and Communication Services, lost value in the first six months of 2024.

2024 Mid-year review of S&P 500 sector ETFs. Total Returns. Source: https://www.etfreplay.com/charts.aspx
2024 Mid-year review of S&P 500 sector ETFs. Total Returns. Source: https://www.etfreplay.com/charts.aspx

Best ETF investment performers of 2024

As the chart above shows, the technology sector continues to outperform the broader index. As our favorite WSJ writer recently described, the three largest stocks in the S&P 500 (Microsoft, Apple, and Nvidia) contributed more than 20% of the total market value of the index. In fact, eight of the top ten stocks in the S&P 500 index are technology stocks. This outperformance still appears to be attributable to the substantial investor interest in artificial intelligence (AI) and how this interest is impacting other sectors, like utilities.

Outlook

While we won’t try to estimate where markets will go from here, it does seem reasonable that stock-picking to beat the S&P 500 will continue to be challenging. Thus, the high concentration of technology stocks in this index continues to propel the performance of this market cap weighted index. As a result, if the technology sector does falter, the diversification of this index may help reduce volatility.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in tax-efficient investing with ETFs
Posted on

Utility ETFs outperforming

Returns of utility ETFs have been particularly strong over the past three months, exceeding the returns of the S&P 500 index ETF by over 10%. Our favorite WSJ writer mentioned this situation recently, along with some explanations. In this post, we explore other aspects worth considering with utility ETFs.

What is in a utility ETF?

Several ETFs focus their holdings on utility companies. The largest is the Utilities Select Sector SPDR Fund (ticker: XLU), which is over twice as large as the next largest utility ETF, the Vanguard Utilities ETF (ticker: VPU). But, these ETFs track two different indices. XLU tracks the S&P Utilities Select Sector Index, while VPU tracks the MSCI US Investable Market Utilities 25/50 Index. Consequently, XLU has 31 holdings, less than half of the 67 in VPU. However, examining the top ten holdings in each ETF reveals they are very similar. So, not surprisingly, the year-to-date returns for both of these ETFs are identical, at 12.25%.

Top Ten Holdings of the two largest Utility ETFs, as of May 31, 2024. Source: etf.com

What is driving energy demand?

As Jason Zweig’s noted in his recent article, Artificial Intelligence (AI) may be playing a role. Training AI models are very energy-intensive. And, as we’ve written about before, the largest companies in the S&P 500 are actively involved in AI development. But, Maria Pope, CEO of Portland General Electric, believes there are three big drivers increasing electricity demand in the U.S.

  • Manufacturing returning to the U.S.
  • Government support of semiconductor production.
  • Data centers and their need to train and run AI models.

Will this demand remain elevated for the foreseeable future? And, how will the markets respond? ETF investors should consider these points when evaluating sector ETFs like those focused on utilities.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in tax-efficient investing with ETFs
Posted on

Bond funds continue to challenge investors

Bond funds continue to challenge investors seeking less risk from the stock market, but also retaining buying power. My favorite writer Jason Zweig also wrote about this recently, along with many of his readers’ opinions. In this post, we illustrate what’s been happening over the last year since we last wrote about bond ETFs.

Bond funds and their time to maturity

Bond fund performance over the last year appears to still be heavily dependent on their time to maturity. As the image below shows, the total return of the shortest-term U.S. treasury bill ETF (ticker: BIL) was gradual and positive. The intermediate-term bond fund (ticker: AGG) nearly broke even for the last 12 months. The long-term bond fund (ticker: TLT) was most sensitive to rising interest rates and had the largest loss and most volatility over the past 12 months.

Shorter-term bond ETFs continue to perform well with low volatility. Source: etfreplay.com
Shorter-term bond ETFs continue to perform well with low volatility. Source: etfreplay.com

Bond ETFs with shorter terms to maturity

Staying with shorter-term ETFs has become much easier with several options for investors to consider. Here is a short list to consider:

  • SPDR Bloomberg 1-3 Month T-Bill ETF (ticker: BIL)
  • iShares Short Treasury Bond ETF (ticker: SHV)
  • Goldman Sachs Access Treasury 0-1 Year ETF (ticker: GBIL)
  • iShares 0-3 Month Treasury Bond ETF (ticker: SGOV)

Referring to the image above, we see that the SPDR Bloomberg 1-3 Month T-bill ETF returned 5.3%. And, as we have written about previously, this return is exempt from state taxes. This exemption is significant for states like California and Hawaii, but irrelevant for states like Texas and Florida that have no state income tax. In any case, with current inflation around 3%, these short-term investments are helping ETF investors to maintain and slightly grow their buying power.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in tax-efficient investing with ETFs
Posted on

Optimal decisions under price dynamics for Roth conversions

As the April 15th tax deadline approaches, many retirees may be considering the trade-offs associated with Roth conversions. Seeking optimal decisions can be challenging! In this post, we highlight a peer-reviewed journal article recently published in the Financial Planning Review and add to our previous discussion on this topic.

Optimal decisions under price dynamics for Roth conversions
“Optimal decisions under price dynamics for Roth conversions”
James A. DiLellio, Philip M. Goldfeder, Edward F. McQuarrie

Timing your tax payments

Ordinary income taxes may occur during retirement from tax-deferred account distributions, like withdrawals from a 401(k) plan. However, by conducting a Roth conversion, a retiree can move these tax-deferred assets to a Roth account where future withdrawals are generally tax-free. But, to do so, they may owe taxes on the distribution. There are other rules too. For example, retirees may not convert required minimum distributions. Nevertheless, many financial planners consider Roth conversions when a client’s taxable income is unusually low, thereby taking advantage of lower tax rates in our progressive tax system.

Key Insights

This article provided many important insights when seeking optimal decisions on Roth conversions.

  • If funding the Roth conversion from retirement assets, the conversion will be solely dependent on future tax rates. Thus, the conversion will have a positive (negative) payoff if future tax rates are higher (lower) than the rate paid to convert.
  • If funding the Roth conversion from non-retirement taxable assets, the cost basis of these assets plays an important role. So, the lower the cost basis of these assets used to fund the tax liability caused by the conversion, the less likely that a positive payoff will occur.
  • Using non-retirement assets to fund the Roth conversion’s tax liability also creates a payoff dependent on market returns. Stronger market returns lead to a greater payoff. Also, the calculus of this optimal decision changes significantly whether the non-retirement assets will ever need to be used by the retiree, or if they will receive a step-up in cost basis when left to an heir.
DiLellio-Goldfeder-and-McQuarrie-2023-Optimal-decision-under-price-dynamics-for-Roth-conversion-FPR

The bottom line on optimal decisions for Roth conversions

Making an optimal decision on converting tax-deferred retirement funds to a Roth IRA is not simple. As the results of this research show, there may be situations where it is worthy of consideration. But, there are also many scenarios when Roth conversions should not be pursued. Not sure how it may affect your situation? Our optimal retirement income calculator now includes a Roth conversion analysis. And, you can try it for free!

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in tax-efficient investing with ETFs
Posted on

AI and the S&P 500

Artificial intelligence (AI) continues to impact markets like the S&P 500 in 2024. If you are already invested in broad-based ETFs, you may be invested in AI, whether you realize it or not. In this post, we discuss how AI companies are influencing cap-weighted indices.

close up photo of monitor
Photo by energepic.com on Pexels.com

Fear of Missing Out

Jason Zweig at The Wall Street Journal recently wrote an article about one of the leading AI companies Nvidia. In his article, he noted how this company was now more than 4% of the S&P 500 index, thanks to its recent rise in share price.

And, other companies working in the AI space are also seeing very positive share price increases, like Microsoft. In fact, according to this page on ETF.com, Microsoft and Nvidia now account for about 11.5% of the S&P 500 index. This weighting of AI in the S&P 500 is due to the S&P 500 being a “cap-weighted” index.

A stock market index wherein each component is weighted relative to its total market capitalization

What is a Capitalization-Weighted Index? source: Corporate Finance Institute (CFI)

So, even if an investor thinks they may have “missed out”, they have not if they owned an S&P 500 ETF or some other cap-weighted index fund.

Other firms in the S&P 500

Because the S&P 500 is cap-weighted, the firms in this index become more (or less) significant as their market capitalization increases (or decreases). The image below shows the current top-10 holdings in the S&P 500 ETF (ticker: IVV). Note that over half of those in this list are tech firms that are at the forefront of AI. In fact, for investors in Apple, there may not be enough investment in AI.

Top 10 holdings in the S&P 500 ETF IVV. Source: etf.com
Top 10 holdings in the S&P 500 ETF IVV. Source: etf.com

ETF investor options to embrace or avoid AI

Hopefully, ETF investors realize that they may already have AI investments, if they are invested in one of the ETFs tracking the S&P 500, like VOO, IVV, or the oldest ETF SPY. Alternatively, ETF investors wishing to embrace AI more may seek tech-centric ETFs, like XLK. Or, by seeking dividend-paying stocks not seeking growth from AI, an ETF investor may seek funds like DVY or VTV. Investor preference for growth in the AI space will likely affect investments for many years to come.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
ETFMathGuy is a subscription-based education service for investors interested in tax-efficient investing with ETFs

Oh hi there 👋
It’s nice to meet you.

Sign up to receive expert commentary in your inbox, every month.

This field is required.

We don’t spam! Read our privacy policy for more info.