Periodic commentary on ETFs to improve your investment knowledge.

December 16, 2019December 16, 2019

Retirement Calculator by ETFMathGuy

Seasons greetings to all! We hope this post finds you well. We are happy to introduce a new and evolving feature available to ETFMathGuy subscribers: a new Retirement Calculator!

Retirement Calculator

You may have noticed a new menu option when logging into ETFMathGuy.com labeled “Retirement Calculator”. Please be sure to log-in to our site to access this interactive calculator. If you don’t recall your password, it can be reset here. You also may need to refresh the page containing the calculator.

Another Retirement Calculator?

There are certainly many retirement calculators available online, either free, as part of your brokerage account, or by subscription. I have been using the Fidelity Retirement Income planner for some time, which is free to Fidelity account holders. While there are similarities between our retirement calculator and others, here are a few of the features our retirement income planner includes.

We assume qualified stock dividends and non-qualified bond dividends. Some planning tools tax stock and bond dividends the same. So, we made the assumption that stock and bond investments in a taxable brokerage account hold ETFs like the iShares Core S&P 500 ETF (ticker IVV) and the iShares Core U.S. Aggregate Bond ETF (ticker AGG).
We assume taxable account withdrawals trigger only long-term capital gains taxes. Some planning tools include all taxable account withdrawals as part of ordinary income, which only occurs for capital gains in investments held for less than one year.
We model capital gains taxes and qualified dividends at either the 0%, 15% and 20% rates, with income levels based on taxable income for the current tax year. Some planning tools either exclude taxation of these sources of retirement income, or tax them all at the 15% rate.

Questions or feature requests

We encourage you to try out our new calculator, which also provides more detailed information on how it models retirement income and taxes. We also would love to hear about features you would like to be included in the calculator as its development continues.

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

December 1, 2019December 1, 2019

December 2019 optimal portfolios and ETF industry consolidation

The December 2019 optimal portfolios are now available to ETFMathGuy subscribers. So, please log in and select your discount broker to see the effect of current market conditions on your optimal portfolios. In this post, we will also discuss some consolidation in the ETF industry and how it may affect your brokerage accounts.

ETFs can be a low-cost way to invest in the stock and bond markets. But, consolidation is occurring with ETF brokers. — Source: WSJ.com

Schwab announces its purchase of TD Ameritrade

The announcement of a consolidation in the discount brokerage industry occurred in November. The $0 commission fee war started recently likely contributed to this industry change . This news is especially problematic for ETrade, who manages 5.3 million brokerage accounts. By comparison, Fidelity has nearly 30 million brokerage accounts and the combined Schwab and Ameritrade would have 24 million. Given that discount brokers increase profitability with the scale of their operations, ETrade could struggle in the coming years. Or, put another way, commission-free ETFs are reducing revenue of discount brokers. There is interest at ETrade for an acquisition, but no firms have stepped forward yet.

“If you put your hand up and say you’re on sale, and nobody shows up, that can be seen as a negative,”
Devin Ryan, an analyst at JMP Securities, discussing ETrade’s interest in being acquired.

Should you switch to a different broker?

A recent review of online brokers put ETrade in 4th place. There was a 3-way tie for 1st place between Schwab, Ameritrade and Fidelity. Vanguard appeared in 5th place. Our opinion is that the subtle differences between brokers may be indistinguishable to many retail investors. We believe costs should be paramount as they create a drag on investment returns. For this reason, we recommend that if you are already with one of these five brokers, it probably isn’t worth the time to make a change. However, you may wish to revisit this decision if industry consolidation continues and fees change.

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

November 15, 2019November 15, 2019

More ETFs trading commission-free

The year of 2019 has seen a dramatic shift in the costs to trade ETFs. There are now four discount brokers who offer nearly all ETFs commission-free, including Ameritrade, Fidelity, Schwab and Vanguard. But, as we’ve discussed previously, investment returns depend on another cost too. We discuss this other cost here, and suggest alternatives to help minimize it.

How many commission-free ETFs are there now?

There are many ETFs available today covering broad and narrow aspects of the market. According to my favorite screener at ETF.com, and excluding leveraged and inverse ETFs, there are 2,052. That is a lot of choices for any investor to consider. Here at ETFMathGuy, we prefer optimal portfolio construction. That is, selecting ETFs that compliment one another in a diversified portfolio. Prior to this construction, we also screen ETFs to ensure each portfolio avoids ETFs with (i) low volumes and (ii) short track records.

The other cost: the bid-ask spread

The hidden cost of buying and selling an ETF is the bid-ask spread. So, investors should conduct some due diligence to reduce this cost whenever possible. Based on the latest data from ETF.com, we constructed the chart below. As it shows, thinly traded ETFs or ETFs that have less-liquid underlying securities still persist in about 10% of ETFs available today. Fortunately, a little more than half of ETFs have a bid-ask spread under 0.15%.

Number of ETFs and their bid-ask spreads, as of November 2019. — Source: ETF.com’s ETF Screener & Database

Conclusions

Commission-free ETFs are good news, as they reduce the cost of investing in ETFs. However, care should be taken to avoid other costs, like the bid-ask spread. To help avoid this cost, investors should seek more liquid ETFs with lower bid-ask spreads, or find ways to trade less frequently. In any case, commission-free doesn’t mean there are no transaction costs, and investors would be wise to choose their ETFs with care.

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

November 2, 2019November 2, 2019

November 2019 Portfolios and a Thank You to our Subscribers

The November 2019 optimal portfolios are now available to ETFMathGuy subscribers. So, please log in and select your discount broker to see the effect of current market conditions on your optimal portfolios. In this post, we will also discuss some changes to ETFMathGuy.com for 2020, and a special offer for current subscribers.

Changes coming to ETFMathGuy.com for 2020

2019 has been a good year for ETFMathGuy.com. We have seen significant growth of investors interested in optimal portfolios using ETFs. Our subscriber base has also grown substantially, but so has our cost of running this service. So, beginning in January of 2020, we will be making changes to our subscription program. Subscription pricing will become as follows:

$9.95 / month or $79.95 / year for individuals

If you are a financial adviser and wish to continue using our portfolios to help guide investment decisions for your clients, please contact us for institutional pricing. This pricing will apply to portfolios we produce each month from the following brokers’ commission-free ETFs: Ameritrade, ETrade, Fidelity and Schwab

As a “thank you” for anyone who starts a free subscription before the end of the year, will will provide discounted subscription fees. So, please share this opportunity with other like-minded ETF investors you may know, and stay tuned for more details!

Continuing benefits of a free subscription

We realize that some of you may not want to pay for a subscription. So, for those who don’t upgrade, your free subscription will continue. Your free subscription will include access to the Vanguard optimal portfolios. It will also include email updates on our periodic commentary on market conditions and trends in ETFs.

Optimal portfolios using Vanguard Commission-free ETFs will continue to be available without a monthly or annual subscription fee.

Thank you all for an amazing first year of ETFMathGuy!

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

October 14, 2019October 14, 2019

Is direct indexing better than buying an ETF?

Direct indexing may be gaining popularity soon, thanks to a continued fee war between several large brokerages. Both Schwab and Ameritrade recently announced commission-free stock trades, in addition to their commission-free ETF trades. This may sound like an appealing alternative, but direct indexing is far from simple.

What is direct indexing?

Direct indexing creates a portfolio that tracks an index through buying individual stocks. So, in the case of the S&P 500, you would invest in common stock from the 500 companies that make up the index. By eliminating the commission for each trade, the cost barrier of buying and selling each stock goes down significantly. However, it still requires many trades. In the case of the S&P 500, there are actually 505 common stock listings for the 500 companies in the index. It turns out that a few companies, like Google, have two share classes. So, one could eliminate the expense ratio of 0.04% currently charged by the iShares Core S&P 500 ETF (ticker: IVV). For a $100,000 portfolio, that is a savings of $40 a year. For portfolios of this size, I would argue that the convenience of trading a single ETF is worth $40 a year.

Tax benefits of direct indexing

When an investor builds a portfolio of common stock with direct indexing, they get more control over its holdings. While ETFs are known to be very tax efficient, tax loss harvesting is not possible at the individual security level. This benefit doesn’t make a difference in retirement accounts that aren’t paying taxes on selling stocks, but can be significant in taxable accounts for high income earners.

Conclusions

I am happy to see commissions for stock trades hitting $0, but I’m not convinced that for most investors, direct indexing makes sense. There is a cost savings, but the additional effort could be significant. And, if your larger investments are in tax-deferred or exempt retirement accounts, there aren’t any tax benefits available anyway. Tax loss harvesting appears to be the most compelling reason to direct index. It is most beneficial to individuals paying the highest marginal tax rates.

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

October 1, 2019October 1, 2019

October Portfolios and Third Quarter Market Summary

The October 2019 optimal portfolios are now available to subscribers of ETFMathGuy. So, please log in and select your discount broker to see the effect of current market conditions on our optimal portfolios. Here, we also summarize the market dynamics in the third quarter.

Third Quarter Market Summary

Today’s issue of the Wall Street Journal had several articles that nicely summarized the latest quarter for ETFs. Today, I discuss two articles. The first deals with investing in precious metals, and the second with preferred stock.

Precious Metals

The first article discusses the opportunity of investing in precious metals in a rate falling environment. The author points out that holding precious metals, like the popular gold ETF (ticker: GLD) or sliver ETF (ticker: SLV) don’t produce a yield like stock and bond ETFs. Then, the article goes on to suggest the “safe haven” aspect of precious metals may be driving their demand. The image below shows that the opportunity for large gains is possible, if investors are willing to accept a high degree of volatility.

Preferred stock

The second article discusses a hybrid stock-bond fund that tracks preferred stock. This investment has characteristics of both common stock and bonds, as seen by its performance shown below for a preferred stock ETF (ticker: PGX). Because the riskiness of preferred shared typically falls between stocks and bonds, it is not surprising its returns do too.

Returns of preferred shares ETF vs. stock and bond markets. Source: WSJ, October 1, 2019.

Conclusions

The financial markets continue to exhibit very dynamic behavior. But, ETFs continue to offer an opportunity to reach parts of the markets in a cost and tax efficient manner. So, we hope this article helps to inform your decision making when selecting ETFs.

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

September 23, 2019September 23, 2019

Making sense of ETF Liquidity

In my last post, I discussed ETF liquidity risk. After the post, a subscriber to ETFMathGuy asked me to talk more about this risk and how it relates to the wide variety of commission-free ETFs now available.

Bid-ask Spreads

Bid-ask spreads are an excellent way to measure liquidity. Less liquid ETFs generally have higher bid-ask spreads. But, the liquidity of the securities held by the ETF also affects bid-ask spreads. The image below shows the distribution of bid-ask spreads for Fidelity commission-free ETFs, which I updated from my April 2019 post.

Bid-ask spread of Fidelity Commission-Free ETFs, as of 9/22/2019. Source: ETF.com, Fidelity.com

Minimizing costs

As we see from these results, there is a wide variation of bid-ask spreads. So, about half have spreads under 0.1%, and about 80% under 0.3%. For ETFs traded commission-free, these spreads are likely the largest contributor to cost of ownership. To reduce this cost, an investor can either buy-and-hold for extended periods, or choose ETFs with lower bid-ask spreads. Investors should also avoid trading ETFs close to the market open and close. Higher volatility over a typical trading day can often occur close to the market’s open and close, and can produce higher bid-ask spreads.

What about ETF liquidity during high market volatility?

It is very likely that, during periods of high market volatility, bid-ask spreads will grow. This growth is simply the result of finding a balance between supply and demand. Or, in the case of ETFs, this balance occurs when an ETF seller finds a buyer. Remember that, due to liquidity risk, we can expect a return premium over risk-free investments. If market volatility is a concern, investors should seek lower volatility investments (e.g. bonds over stocks), and/or seek lower volatility in their portfolio through diversification.

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

September 11, 2019September 11, 2019

Is there a bubble in ETFs?

The “hero” of the movie “The Big Short”, Michael Burry, has made some claims recently about a bubble in ETFs and market risks. Here, I discuss his concerns, and provide an alternate perspective.

Price discovery

One of the risks Michael Burry identifies is so-called price discovery. He claims that index funds have removed price discovery from the equity markets. I must disagree with this claim. For example, when an investor buys an S&P 500 index ETF, they are agreeing to pay the seller some price. This transaction is an implicit agreement on the value of the underlying securities. So, this is the very definition of price discovery, where supply and demand are in equilibrium.

” Simply put, it is where a buyer and a seller agree on a price and a transaction occurs. “
Definition of Price Discovery, Investopedia.

Liquidity Risk

Michael Burry also identifies liquidity risk, which occurs when an investor has trouble selling an investment at a desirable price. Liquidity risk is very real. ETF investors often realize this risk during significant market corrections through larger bid-ask spreads.

“…liquidity risk stems from the lack of marketability of an investment that can’t be bought or sold quickly enough to prevent or minimize a loss.
Definition of Liquidity Risk, Investopedia

While I agree that there is liquidity risk in ETFs, there is also liquidity risk in just about any financial investment. For instance, homeowners often face liquidity risk. So, you may wish to sell you home next month to move for a new job, but may not able to find a buyer willing to pay your asking price. In stock and bond ETFs, liquidity risk also occurs during times of market corrections. But, this risk occurs whether you own the individual stock, bond, or a fund that contains them. Taking this risk is part of the risk-reward payoff. That is, by taking additional risk, the investor realizes the possibility of higher returns.

Conclusions about a bubble in ETFs and market risks

So, how should an individual investor treat this opinion? Michal Burry’s solution is to be “… 100% focused on stock-picking.” My choice is to stick with ETFs, thanks to their simplicity and efficiency. Markets corrections will occur, so it’s not a matter of if, but when they occur. If, as an investor, you are not comfortable with these market risk, perhaps you should re-evaluate your risk tolerance and move to lower risk investments.

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

September 2, 2019September 2, 2019

September portfolios and year-to-date returns

The September 2019 optimal portfolios are now available to subscribers of ETFMathGuy. So, please log in and select your discount broker to see the effect of current market conditions on our optimal portfolios. In this post, we discuss the year-to-date returns of my personal account using the ETFMathGuy portfolios.

Year-to-date returns

Although there are still four months remaining in the year, I thought this would be a good time to talk about my year-to-date returns. I have personally been using the moderate risk level portfolios in my Fidelity brokerage account since the beginning of the year. Monthly returns, based on the balance in my account, appear below.

Monthly returns using commission-free Fidelity ETFs and the moderate ETFMathGuy risk level.

To better understand the returns in my account that maximizes return for a portfolio with volatility half-way between stocks and bonds, I created the next table. Here, you can see that the ETFMathGuy portfolio return so far in 2019 is 14.1%, with a monthly volatility of 2.1%. To one decimal place, the same volatility is seen if an investor had simply maintained a 50% stock and 50% bond fund, re-balanced each month. But, the 50/50 portfolio would have seen a return of only 13.7%

ETFMathGuy portfolio returns are higher than a 50/50 stock/bond portfolio, with the same volatility.

Key takeaways

The ETFMathGuy portfolios appear to be behaving as expected. That is, they have about the same amount of volatility as their benchmark. However, I realized an additional return of about 0.4% in my brokerage account. For a $100,000 portfolio, that is an additional gain of about $400. I will revisit my portfolio’s performance again at the end of the year, so please stay tuned!

The future of ETFMathGuy

For the near future, I will continue to provide the optimal portfolios without a fee. But, in the meantime, I decided to begin accepting donations, if you are so inclined. Please find the donate button at the bottom of the “Join Us” page. For your convenience, it also appears below.

Thanks for supporting ETFMathGuy!

Thank you all for your interest and support in 2019. I hope you all had a wonderful labor day weekend!

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

August 21, 2019August 21, 2019

ETF Investments and inverted yield curves

In this post, I discuss a very popular topic in the financial news recently. The term “inverted yield curve” has come up quite a bit. Many consider it as a good indicator of a recession. So here, I will review the fundamentals on what a yield curve is. Then, I’ll comment on its relevance to ETF investors.

The Yield Curve

The yield curve visualizes U.S. treasury bond yields at various times to maturity. As of August 20, 2019, the yield curve looked like this.

Yield curve on August 20, 2019. source: https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield

I’ve highlighted with asterisks (*) the yield on the two and ten year treasuries. So, these bond maturities had yields of 1.50% and 1.55%. These two maturities are often picked to represent short-term vs. long-term investments in U.S. treasury bonds. That spread, or difference in yields, is 0.05% as of August 20, 2019. Of course, if we chose “short-term” as 1 year, then indeed we would have an inverted yield curve with a spread of -0.17%. In any case, the two-to-ten year spread is very small, as compared to what has been seen so far in 2019.

Spread between two and ten year U.S. treasury bonds. source: https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yieldYear&year=2019

What does a smaller (or negative) spread mean?

The general argument is that demand for longer term bonds is growing as investors flee the volatility of the stock market. This flight to bonds, or preferably bond ETFs, does seem to be prudent, particularly for investors with high concentrations of stock investments seeking to better manage stock market risk. So, I would argue that, if you have a well diversified portfolio of stocks and bonds, one can largely ignore all this discussion of the inverted yield curve. Instead, investors should focus on their own risk tolerance and long-term goals, as all markets correct themselves from time to time.

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

Retirement Calculator

Another Retirement Calculator?

Questions or feature requests

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Schwab announces its purchase of TD Ameritrade

Should you switch to a different broker?

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How many commission-free ETFs are there now?

The other cost: the bid-ask spread

Conclusions

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Changes coming to ETFMathGuy.com for 2020

Continuing benefits of a free subscription

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What is direct indexing?

Tax benefits of direct indexing

Conclusions

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Third Quarter Market Summary

Precious Metals

Preferred stock

Conclusions

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Bid-ask Spreads

Minimizing costs

What about ETF liquidity during high market volatility?

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Price discovery

Liquidity Risk

Conclusions about a bubble in ETFs and market risks

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Year-to-date returns

Key takeaways

The future of ETFMathGuy

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The Yield Curve

What does a smaller (or negative) spread mean?

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