Tag: investing

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July 2019 optimal portfolios are now available and discussed in terms of recent and long-term market trends

The July 2019 optimal portfolios are now available to subscribers of ETFMathGuy. So, please log in and select your discount broker. In this post, we will also discuss more about risk and return in an optimal ETF portfolio.

As we mentioned in our last post, there are benefits to having more ETFs to choose from during the portfolio construction process. We showed the potential to increase expected returns. In this post, we highlight another important element – risk.

Risk and Return

Risk and return are two fundamental issue that are important to consider when investing in an ETF portfolio. The chart below shows risk (horizontal axis) and return (vertical axis). Here, we define risk as the annual volatility, measured by the standard deviation of daily returns. We evaluate risk and return using a multi-year sample period selected from our rigorous backtesting process. As this chart shows, the optimal portfolios reside at risk levels between the bond market (ticker: AGG) and stock market (ticker:IVV). And, these portfolios are efficient, since they were selected to maximize the expected return.

Risk (Volatility) and Expected Return in the July 2019 optimal portfolios. Notice that at each risk level (conservative, moderate and aggressive), different ETFs offered by different discount brokers leads to different expected returns.
Risk (Volatility) and Expected Return in the July 2019 optimal portfolios. Notice that at each risk level (conservative, moderate and aggressive), different ETFs offered by different discount brokers leads to different expected returns.

As this chart shows, cash can be nearly risk-less, based on volatility, but offers returns that may not exceed long-term inflation. Bonds can offer more of a potential return, but with added risk. Even more return is possible from the stock market for those willing to accept additional risk.

What about the last 6 months?

Indeed, it is true that the first half of 2019 has been very good for both stocks and bonds. Based on a recent Wall Street Journal article, “… S&P 500 finished Friday up 17% this year, marking its best first half since 1997 “. According to the site ETFreplay.com, and including dividends, the stock and bond market are up 18.3% and 5.8%, respectively, this year. Will this trend continue? I personally doubt anyone really knows, as I believe that markets are generally very efficient. A better question may be “What level of risk” or “How much exposure” do you want your investments to have in various parts of the market. To end this post, I’ll leave you with one (of many) famous quotes by Warren Biuffet.

“The stock market is a device to transfer money from the impatient to the patient.”

Warren Buffett

We hope you found this post 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 using commission-free ETFs in efficient portfolios.
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Opportunities from more commission-free ETFs

Earlier this month, Fidelity followed through on its promise made earlier in the year. They now offers over 500 commission-free ETFs. This increase puts them in 2nd place for most commission-free ETFs offered by the five discount brokers analyzed each month by ETFMathGuy. The leader is still Vanguard, with approximately 1,800. Our chart below shows the update for Fidelity’s offering, where the Vanguard count only represents Vanguard ETFs. (We will be updating our Vanguard database soon.)

Vanguard* count only includes Vanguard ETFs. Vanguard now offers approximately 1,800 ETFs commission-free.
Vanguard* count only includes Vanguard ETFs. Vanguard now offers approximately 1,800 ETFs commission-free.

What is the benefit of more commission-free ETFs in a portfolio?

The most obvious benefit is the opportunity to access portions of the market not previously available. I demonstrated this benefit in previously published research entitled “ETF trading strategies to enhance client wealth maximization“. Here at ETFMathGuy, we have seen these opportunities first hand in our optimal portfolios. Each month, we’ve developed portfolios based on the current number of ETFs offered by each discount broker. We have also calculated the expected return associated with these portfolios, and there appears to be a potential opportunity. When constructing portfolios with more ETFs available, we see in the figure below that expected returns generally improve. Note that the pair of dots next to the portfolios are the result of excluding commission-free municipal bonds when generating a portfolio suitable for an IRA.

Expected return of ETFMathGuy optimal portfolios tend to rise with more commission-free ETFs available

More commission-fee ETFs may not always be beneficial

This figure shows that having more options to invest can improve the likelihood of generating higher returns. But, the additional ETFs must be sufficiently different those that are already offered. They must also have the potential to generate higher returns. Ameritrade seems to be accomplishing the most with their approximately 300 ETFs. Conversely, ETrade offers many more ETFs than the 59 offered by Vanguard, but doesn’t appear to increase expected returns by much in the portfolios constructed by ETFMathGuy .

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 using commission-free ETFs in efficient portfolios.
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June 2019 Optimal Portfolios are Now Available to ETFMathGuy subscribers

The June 2019 optimal portfolios are now available to subscribers of ETFMathGuy. So, just log in and select your discount broker.

You can now view the June 2019 optimal portfolios for the five discount brokers analyzed by ETFMathGuy. These portfolios cover nearly 1,500 ETFs currently offered commission-free from Ameritrade, ETrade, Fidelity, Schwab and Vanguard.

In all cases, we applied our rigorous portfolio construction process to produce the current portfolios. So, we encourage you to browse through these portfolios to review the following characteristics:

  • Allocation of bond versus stock ETFs in the optimal portfolio
  • Turnover from the previous month or months
  • The effect of risk level on the overall portfolio risk statistics
  • The increase in expected return as risk level increases

We hope you find these portfolios educational!

Where are the ESG funds in the 2019 optimal portfolios?

In our mid-April post, we updated the database used by ETFMathGuy to include the expanded list of commission-free ETFs offered by five discount brokers. We also mentioned one of the most popular themes to hit the ETF landscape, called Environmental, Social and Governance (ESG) investing. For example, Vanguard offers two of these ESG funds.

These two ETFs carry an expense ratio of 0.12% and 0.15%, respectively, consistent with Vanguard’s low-cost philosophy. So, why aren’t these funds appearing in the current portfolios developed by ETFMathGuy?

The short answer is that our portfolio construction process requires a sufficient return history. Based on our backtesting results, we identified an optimal sample period of several years. Unfortunately, the two Vanguard ETFs noted above have only existed since September 18, 2018, or about the last 8 and a half months. Consequently, this history is simply too short for our optimization model to generate portfolios that satisfy investor return expectations.

So, is ESG investing worthwhile?

This is an excellent question! In fact, based on a recent Wall Street Journal article, other experts in the industry shared our concern about a short return history.

“Many of these ESG ETFs are relatively young and have not had a chance to prove if they can demonstrate strong performance”

Todd Rosenbluth, senior director of ETF and mutual-fund research at CFRA

What does this mean for you? Well, if you are an investor focused on using your beliefs to guide your investment decisions, you may find this short history acceptable. However, here at ETFMathGuy, we prefer to make evidence-based decisions. So, we look forward to analyzing longer return histories that may show how ESG funds could be part of an optimal portfolio.

ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios. June 2019 optimal portfolios are now available.
ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
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Using diversification to deal with market volatility

A recent Wall Street Journal article discussed the behavioral aspects caused by market volatility. The article nicely summarizes the long term view of the market. Based on historical analysis, there is a 2% drop in the stock market every 33 trading days, on average. With the Dow at its current levels, that is a 520 point drop every 6 weeks or so.

If this amount of volatility is “keeping you up at night”, perhaps your portfolio isn’t properly diversified? I touched on diversification using bonds in my last post, and will discuss diversification more broadly now.

So, what is diversification?

Simply put, diversification is not allowing for concentrated positions in a portfolio. For example, if you have a portfolio of a single stock, this portfolio is not diversified. But, as more stock is added from different companies in different sectors, investors can often reduce portfolio risk. However, market risk remains, as shown below.

Increasing the number of stocks reduces risk, as measured by the standard deviations of periodic returns.
Increasing the number of stocks reduces risk, as measured by the standard deviations of periodic returns.

Going beyond market risk for wider diversification and reduced volatility

A simple approach to managing portfolio risk is through mutual funds or exchange traded funds. Both investment vehicles hold a basket of many securities, eliminating the need to hold individual stocks to properly diversify. Here at ETFMathGuy, we are advocates of ETFs (exchanged traded funds), because ETFs have better tax efficiency, (usually) lower expense ratios, and often trade commission-free.

Now, most individuals also invest outside the stock market. So, they seek diversification by investing in other asset classes too. For instance, bonds tend to “zig” when stocks “zag”. To see an example of this approach, consider the conservative Fidelity optimal portfolio by ETFMathGuy published for March 2019, and shown below.

Taxable portfolio using Fidelity commission-free ETFs reduces volatility

Assuming an investor buys-and-holds this portfolio from March 4, 2019 through May 21, 2019, the growth of $100 appears below. Notice that the large drop at the end of this time period. This volatility, shown in blue as the S&P 500 ETF (ticker: IVV), is largely unnoticeable in the ETFMathGuy optimal portfolio, shown in green.

Comparing volatility of the conservative ETFMathGuy optimal Fidelity portfolio to the S&P 500 ETF
Comparing volatility of the conservative ETFMathGuy optimal Fidelity portfolio to the S&P 500 ETF

Digging into the statistics reveals compelling information about the volatility. The annualized volatility over this period of the ETFMathGuy portfolio is 4.0% versus 11.0% for the S&P 500 ETF. Clearly, diversification across asset classes (like stocks and bonds) can be a very effective way to manage volatility.


ETFMathGuy is a subscription-based education service for investors interested in using commission-free ETFs in efficient portfolios.
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Risks and Opportunities in Fixed-Income ETFs

Fixed-income ETFs (also known as bond ETFs) continue to grow at a rapid pace. Bond ETFs now exist across a wide spectrum of characteristics. Looking for shorter or longer maturity? Or, how about higher yield (aka junk bonds) versus investment grade or Treasury bonds? ETFs even cover the bond markets in both emerging and developed economies worldwide.

At this rate, State Street Global Advisers predicts that assets in bond ETFs could reach $1 trillion by the end of 2019.

What is driving demand?

Like stock-based ETFs, low cost is a big driver. Greater tax efficiency, as we discussed in detail in a post earlier this year, over bond mutual funds helps too. But, the biggest demand could be simply choice.

“Investors really have a lot of choices — more than they’ve had in the past five years. “

Noel Archard, State Street Global Advisors

Liquidity concerns?

Our opinion at ETFMathGuy is that liquidity concerns are minimal. In fact, real-time ETF price availability helps the price discovery process, and should improve liquidity.

“Fixed-income ETFs have been tested more than once over the past 10-11 years, without any major issues. “

Rich Powers, Vanguard

The current focus of fixed-income ETFs

The current focus of fixed-income ETFs is now in portfolio construction. Here at ETFMathGuy, we are helping to lead this initiative by building portfolios to take full advantage of what fixed-income ETFs have to offer. For instance, in the May taxable conservative portfolio for Vanguard, we show a portfolio with a a variety of fixed-income ETFs in it. We also seek to include higher volume alternative ETFs, to mitigate any possible liquidity issues and minimize the bid-ask spread trading costs.

May 2019 taxable optimal portfolio for risk conservative investors, by ETFMathGuy.
May 2019 taxable optimal portfolio for risk conservative investors, by ETFMathGuy

In conclusion, fixed-income ETFs are in important core component of an optimally diversified portfolio. We invite you to browse through the current month optimal portfolios to see the importance of bond 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 using commission-free ETFs in efficient portfolios.
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Zero and negative expense ratio ETFs have arrived.

In the past few months, firms have begun to offer zero expense ratio and negative expense ratio ETFs. In an article recently published by the Financial Adviser, two
zero expense ratio ETFs were mentioned. The first were the Sofi Select 500 ETF (ticker: SFY) and the SoFi Net 500 (ticker: SFYX) . Both have temporarily waived fees until at least June 30, 2020.

Then, Salt Financial filed for an ETF with the Security and Exchange commission, named the Salt Low TruBeta US Market ETF, with a -0.05% expense ratio. That’s right…this fund will pay investors $5/year for every $10,000 invested. Similar to the Sofi ETFs, this offer is good until April 30, 2020, or when the fund reaches $100M in assets under management.

So, do these expenses justify selecting them over other ETFs with similar objectives, but charge a higher rate? A recent survey by Brown Brothers Harriman indicated that for U.S.-based advisers and fund managers, expense ratio was the most important criteria. But, there are other factors worth considering.

Other costs matter beyond expense ratios

As my previous journal article “Is There a Free Lunch in Commission Free ETFs?“, I cited three expenses relevant to ETF investments.

  1. Expense ratios
  2. Trading commissions
  3. Bid-ask spreads

The SoFi Select 500 ETF is easy to compare to other ETFs that track the S&P 500 Index. The table below shows its expenses versus ETFs with similar objectives, and offered commission-free from one of the five discount brokers analyzed by ETFMathGuy.

Individual and Total Expenses for S&P 500 ETFs, assuming $10,000 investment over 1-year.
Individual and Total Expenses for S&P 500 ETFs, assuming $10,000 investment over 1-year.

As this table shows, a prudent investor would recognize that the SoFi ETF average bid-ask spread makes it an inefficient way to invest in the S&P 500.

What about the other ETFs with zero and negative expense ratios?

Evaluating the other securities is more difficult, due to their limited return history. After a longer history is available, the returns of these funds could be compared to other ETFs. Then, we could form a table like the one above with ETFs that have a nearly perfect correlation to these funds. Assuming these firms avoid closing these funds, we plan to look at this topic in the future.

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 using commission-free ETFs in efficient portfolios.
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May 2019 Optimal Portfolios are Now Available to ETFMathGuy subscribers

The 2019 optimal portfolios for the month of May are now available to subscribers of ETFMathGuy. Just log in and select your discount broker.

You can now view the current optimal portfolios for the five discount brokers analyzed by ETFMathGuy. These portfolios cover nearly 1,500 ETFs currently offered commission-free from Ameritrade, ETrade, Fidelity, Schwab and Vanguard.

Portfolios now include updated ETF lineups from Ameritrade, ETrade and Vanguard

As we mentioned in our last post, Ameritrade, ETrade and Vanguard expanded their commission-free lineup. So, the portfolios for the month of May now consider these new funds. Here is a simple count of the number of commission-free ETFs now available from our five discount brokers. Note that IRA accounts exclude the 46 municipal bond ETFs discussed in our recent article.

Commission-free ETFs for Taxable and IRA accounts, as of April 30, 2019

However, this lineup change does not significantly alter the ETFMathGuy portfolios. Remember that several years of price history are necessary to build optimal portfolios. So, ETFs that haven’t been around very long will not be considered as part of the later stages of the portfolio construction process.

Unsure of which discount broker to pick?

If you haven’t yet settled on a discount broker that offers commission-free ETFs, consider the following. Last month, we showed the updated expense ratios and bid-ask spread for Fidelity and Schwab’s commission-free ETFs. Below is the updated information for our other three brokers, Ameritrade, ETrade and Vanguard.

Expense ratios, as of April 2019, for commission-free ETFs offered by Ameritrade, ETrade and Vanguard.
Expense ratios, as of April 2019, for commission-free ETFs offered by Ameritrade, ETrade and Vanguard.

It is pretty clear that, when it comes to expense ratios, Vanguard is the clear winner. The same can be said for Vanguard’s advantage with generally lower bid-ask spreads.

Bid-ask spreads, as of April 2019, for commission-free ETFs offered by Ameritrade, ETrade and Vanguard.

Bid-ask spreads, as of April 2019, for commission-free ETFs offered by Ameritrade, ETrade and Vanguard.

So, is Vanguard the best broker for commission-free ETF portfolios?

This is an excellent question. In terms of number of commission-free ETFs, Schwab is the leader. But, on the basis of cost, Vanguard is the clear winner. What about diversification? Perhaps the diversification benefit of the Schwab (or some of the other discount brokers) can offset their higher costs? We will explore this topic in a future blog post. Stay tuned!

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 using commission-free ETFs in efficient portfolios.
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Discount brokers adjust and expand their commission-free ETF lineup

A few weeks ago, we discussed the expanded commission-free ETF lineup offered by Fidelity and Schwab.

In this post, we revisit the current commission-free ETF lineup offered by the three other discount brokers analyzed by ETFMathGuy. These three brokers include Ameritrade, ETrade and Vanguard.

Ameritrade’s updated lineup of commission-free ETFs

Ameritrade continues to offer 308 commission-free ETFs. Our list used to develop optimal portfolios at ETFMathGuy at the end of last year did change somewhat. Seven ETFs ceased trading in February and March, and most were from WisdomTree.

Seven ETFs ceased trading in February and March, 2019, and were removed from Ameritrade's commission-free ETF lineup.
Seven ETFs ceased trading in February and March, 2019, and were removed from Ameritrade’s commission-free ETF lineup.

Ameritrade replaced these ETFs with seven commission-free ETFs. These replacements come from First Trust, State Street, iShares and Invesco.

Ameritrade added seven funds to their commission-free ETF lineup.
Ameritrade added seven funds to their commission-free ETF lineup.

ETrade’s updated lineup of commission-free ETFs

ETrade made a modest increase to their commission-free ETF lineup, increasing from 259 to 274. Their lineup change was due to removing a number of funds from Vanguard. In addition, and like Ameritrade, many of these ETFs from JPMorgan, Legg Mason and WisdomTree ceased trading.

Fourteen ETFs removed from ETrade's commission-free ETF lineup.
Fourteen ETFs removed from ETrade’s commission-free ETF lineup.

The additional commission-free ETFs offered by ETrade come from a variety of ETF providers, such as Invesco, WisdomTree, iShares and others. The real question here is will these new funds be around for the long haul.

Etrade's commissoin-free ETF lineup includes 29 additional funds.
Etrade’s commissoin-free ETF lineup includes 29 additional funds.

Vanguard’s updated lineup of commission-free ETFs

Vanguard made the smallest change to their list of commission-free ETFs, adding only two funds. Consequently, Vanguard’s total lineup increased from 57 to 59, and embraces a new trend in Environmental, Social and Governance (ESG) investing.

Vanguard expands their commission-free ETF lineup.
Vanguard expands their commission-free ETF lineup.

So what does this mean for an individual investor?

So what this means to an individual investor? A larger number of commission-free ETFs should provide a greater opportunity for diversification and possibly higher returns. Evidence for this appears in the expected returns and volatility estimates in the latest portfolios developed by us at ETFMathGuy. However, what if you are an investor who had invested in one of the ETFs that ceased trading? An article claims that the liquidation process is mostly painless for the investor. It also claims that even if you don’t sell the ETF before it ceases trading, “you are still going to get fair value for the fund based on the final liquidation”. The bigger issue is how removal of the ETF affects your asset allocation and underlying strategy. If you are following the current portfolios at ETFMathGuy, we have already updated our databases to accommodate such a change.

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 using commission-free ETFs in efficient portfolios.
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ETF Tax Efficiency vs. Mutual Funds

Much has been written about ETF tax efficiency. In this blog post, we summarize what these tax advantages look like to a individual investor who may be considering mutual funds as an alternative.

Let’s start with the basics of capital gains taxes. Short term capital gains are taxed as ordinary income, which for individuals in higher tax brackets, is far from ideal. Below are the tax brackets for married filing jointly in 2018.

The 2018 tax brackets and rates for married couples filing jointly.
Source: CNBC.COM. About half of Americans don’t know what tax bracket they’re now in—here’s how to find out., by Kathleen Elkins

So, let’s suppose you and your spouse made $175,000 in 2018. Then, for every additional $1 of short-term capital gains, you owe 24 cents of income tax. If you are fortunate enough to be earning more, tax rates are even higher. For this reason, higher earners often use municipal bond ETFs in their taxable portfolios.

What produces short-term capital gains?

There are several ways that individual investors produce short-term capital gains with ETFs and mutual funds.

  • Buying an ETF or mutual fund and reselling it for a gain in less than a year.
  • Non-qualified dividends, often produced by fixed income mutual funds and ETFs.
  • Mutual funds that buy and sell assets in their fund to meet their stated objectives or to satisfy investor redemption*.

*This last point is where ETFs carry a significant advantage. The higher the turnover of a mutual fund’s assets, the more often short-term capital gains are passed on to the individual investor.

“If your fund distributes capital gains often, your tax bill may suffer.”

Source: “How Often Do Mutual Funds Pay Capital Gains?”, by
Claire Boyte-White, Investopedia.

But, ETFs have a creation/redemption process that shields these gains from the ETF investor. While some would say it’s a tax dodge, this process has represented a significant ETF tax efficiency for over 20 years. Below is a chart that shows how often these events occurred in comparable index ETFs and index mutual funds.

Examples of ETF tax efficiency, by generating fewer taxable gains than mutual funds.
Source: Bloomberg.

Conclusions

Tax efficiency is an important aspect that individual investors should consider. ETFs generally offer better tax efficiency than comparable mutual funds. While this efficiency is important for all investors, higher wage earners can reap the greatest tax benefits of using ETFs versus mutual funds.

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April 2019 Optimal Portfolios are Now Available to ETFMathGuy subscribers

The 2019 optimal portfolios for the month of April are now available to subscribers of ETFMathGuy. Just log in and select your discount broker.

You can now view the current portfolios for the five discount brokers analyzed by ETFMathGuy. These portfolios cover over nearly 1,500 ETFs currently offered commission-free from Ameritrade, ETrade, Fidelity, Schwab and Vanguard.

What’s new? Full ETF names, portfolio & benchmark statistics, and portfolios for taxable and IRA accounts.

So, what’s new this month? First, we’ve added the full name of the ETF, so that subscribers don’t need to look up individual ticker symbols. For instance, the portfolios continue to favor the utility sector. So, for example, the Vanguard portfolio lists both the ticker “VPU” and its full name, “Vanguard Utilities ETF”, in the portfolio tables.

New information available on 2019 optimal portfolios from ETFMathGuy
New information available on 2019 optimal portfolios from ETFMathGuy

Second, we’ve added portfolio annualized statistics for expected return and volatility. Now, it is clear what the risk levels are set to in portfolio construction, regardless of the discount broker. For the month of April, annualized risk levels were

  • Conservative: 5.7%
  • Moderate: 8.3%
  • Aggressive: 11.0%

Third, we’ve added benchmark statistics. These measures are an excellent way to understand how the optimal portfolios match up to the broad stock, bond and cash benchmarks used by ETFMathGuy.

Last, but not least, we’ve run our portfolio construction process to include and exclude municipal bond ETFs. As mentioned in our recent post, brokers like Fidelity often restrict the use of municipal bond ETFs in IRA accounts. The summary table at the top of the current portfolios now indicate either Taxable or IRA (no munis).

We hope you find these 2019 optimal portfolios insightful and educational! If you enjoyed reading this post, we hope you will share it with others in your personal or professional network. Just click one of the icons below. And, for a limited time, subscriptions are 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 using commission-free ETFs in efficient portfolios.