Stuck With a High-Expense-Ratio Fund? Here’s a Google Sheet to Weigh the Pros and Cons of Dumping that “Stinker” in Your Portfolio!

This is a question that’s been on my mind for a while, partially out of curiosity and also because it’s been raised by readers a few times: Suppose you didn’t get the “memo” on passive investing early enough in your life and you now have some high-expense-ratio funds in our portfolio. So, is it too late to switch to a low-cost fund now? Maybe you’re lucky and your funds are actively-managed and they actually beat the broad index reliably. Good for you, but more often than not people are unhappy with the performance of their high-fee funds and like to switch to a low-fee, passively-managed index mutual fund at Fidelity, Schwab or Vanguard. Or move to one of the many index ETFs. Fees will be in the low single-digit basis points, around 0% to 0.015% for some of the Fidelity index funds and around 0.035% for the “Admiral Shares” Vanguard funds. Of course, if this is a fund in a tax-advantaged account where you can just switch between funds without any tax consequences you should just do so if you have that option. But the story gets a lot more complicated in a taxable account! We now have to weigh the pros and cons of switching to a low-cost fund:

Pro: You get rid of that “stinker” mutual fund and replace it with a low-fee, or even zero-fee index fund and eliminate the drag from the high expense ratio. We could be talking about a 0.5% difference in fees and maybe as much as 1.0 or 1.5%. And that’s every year! This can accumulate to a very large pile of cash over time!

Cons: You may have to realize capital gains today. There is a tax inefficiency from having to realize capital gains before you actually need the money in retirement. And this inefficiency takes two forms:

1) for most of you, there’s a good chance that marginal tax rates will be lower in the future, especially in retirement. Your high income right now might put you into a high marginal tax bracket (both Federal and State), while in retirement you might face much lower (or potentially zero) marginal rates. It’s best to defer capital gains until then!

2) even if your future projected tax rate is the same, there’s a potential inefficiency due to realizing capital gains twice; once today when switching to the new fund and once in the future when liquidating that fund in retirement, thus compounding the drag from taxes. It’s best to defer capital gains and pay taxes only once in retirement.

So, depending on how much in built-in capital gains you have right now, how much you can lower your expense ratio and what your current and projected future tax rates are, it may be optimal or suboptimal to dump that high-expense fund. In other words, it is the choice between two evils: The one evil is the drag from the high expense ratio and the other is the drag from tax inefficiency. Which one outweighs the other? Hard to tell, unless you put some numbers in a spreadsheet and do a proper “horse race.” And that’s what we do here today. Let’s take a look…

Continue reading “Stuck With a High-Expense-Ratio Fund? Here’s a Google Sheet to Weigh the Pros and Cons of Dumping that “Stinker” in Your Portfolio!”

Passive income through option writing: Part 3

Back in 2016, I wrote a few posts on trading derivatives, especially options, to generate (mostly) passive income:

I’m still running that same strategy but it definitely evolved quite a bit over time. This might be a good time to write a quick update on what I’m doing and what I’ve changed since then. And for everyone who’s wondering what’s the use of this: I’m planning a future post on how selling options may help with Sequence Risk, so this is all very, very relevant even for folks in the FIRE crowd!

So, let’s take a look…

Continue reading “Passive income through option writing: Part 3”

Here’s an idea for a new ETF

Actually, not one ETF, but two! Or more! How can there be a need for a new ETF? Aren’t there enough already? Earlier this year, Motley Fool argued there are too many ETFs (1,929 at that time, probably over 2,000 by now) and they are covering pretty much every thinkable (and unthinkable) benchmark. Soon we might have more ETFs than publicly traded equities in the U.S., how crazy is that??? Why would I propose a new ETF that doesn’t already exist?

Here’s some background. I’m an index investor at heart and I like tax optimization. For so many years now, I’ve held equity index ETFs and Mutual Funds in both taxable accounts and tax-deferred accounts (both retirement and deferred compensation at work). It’s so painful to see the dividend payments in the taxable accounts getting taxed every year. Sure, it’s only about 1.9% dividend yield in the S&P500 right now but for us, that’s taxed at 15% federal, 10+% state (California!) and 3.8% Obamacare tax, for a total of almost 30% marginal tax! Isn’t there a better way? Sure! Simply put the taxable equity allocation into stocks that pay zero (or close to zero) dividends and keep the high-dividend stocks in the tax-deferred account where they can compound in peace and be taxed only once upon withdrawal rather than every year along the way! So, the two ETFs that I wish existed would exactly replicate the S&P500 if held in equal shares. But individually they’d have non-index weights and one would hold the equities with the lowest dividend yield and the other with the high-yield equities!

Notice that most folks already do this tax optimization across asset classes: Hold the tax-inefficient asset classes (bonds, REITs, etc.) in tax-deferred accounts and equities in taxable accounts. So, why not do this within the equity asset class as well for additional tax efficiency? How much extra after-tax return would we get out of this? Let’s look at the numbers…

Continue reading “Here’s an idea for a new ETF”

My podcast appearance on Millionaires Unveiled

Late last year, I chatted with Jace Mattinson and Clark Sheffield at Millionaires Unveiled. It’s a fairly new podcast but they’ve already lined up an impressive list of guests including Dr. Dahle, aka White Coat Investor and Mindy and Carl from 1500 Days. I also particularly appreciate the diversity of different investment styles. Not everybody becomes a millionaire by investing in VTSAX! We can also learn from real estate investors and business owners! But first, of course, please listen to Episode 15 with yours truly, which was released today…

—> Click here for the podcast on iTunes <—

—> Click here for the podcast on Stitcher <—

And please also subscribe, review and “like” them on iTunes and StitcherContinue reading “My podcast appearance on Millionaires Unveiled”

Active Investing: Opportunity vs. Futility

Almost everywhere in life, the word “active” has a positive connotation. An active lifestyle, an active personal life, an active participant in a discussion, etc. In contrast, “passive” stands for low-energy, dull and boring. Imagine setting up a friend on a blind date with a nice gal/guy who has a really great “passive lifestyle” and see how much excitement that generates.

But investing is different. Passive investing is the rage right now! It is a noticeable market trend in finance overall and the Financial Independence blogging world seems particularly subscribed to the passive investing idea. For the most part, I agree with the superiority of passive investing. But then again, not all active investment ideas are created equal. And that means that we are at risk of throwing out the baby with the bathwater!

Has the Personal Finance Passive-Pendulum swung too far? Are we willfully ignoring some useful principles from active investing for fear of shaking the foundations of the Passive Investing Mantra? 

Take the following five examples of active investing. They all fall into different spots on the Futility vs. Opportunity spectrum:

  1. Stock picking.
  2. Style investing, i.e., tilting the portfolio toward a theme such as dividend yield, small stocks, value stocks, low volatility stocks, etc., or a combination of them.
  3. Allocation to different asset classes (e.g. stock, bond, cash, alternatives) in response macro fundamentals (P/E ratios, bond yields, volatility, etc.).
  4. Changing the major asset weights over the life cycle, e.g., using an equity glidepath to retirement and even throughout retirement.
  5. Setting the initial safe withdrawal rate in retirement and all subsequent withdrawal rates in response to changing market conditions.
FutilityVsOpportunity diagram
Not all forms of “Active Investing” are created equal!

It would be a mistake to apply the same passive investment mantra to all five aspects of personal finance. So, that’s what today’s post is about: Where should we stay away from active investments and where can we learn something from active investment principles? Let’s look at the five active investment themes in detail…

Continue reading “Active Investing: Opportunity vs. Futility”

We just saved $42,000 by not switching to Betterment

There is a popular car insurance commercial featuring someone who “just saved a ton of money by switching to GEICO.” How much is a ton of money? $400? Well, by that measure we just saved more than “100 tons of money” or a whole century worth of car insurance savings. And we didn’t do so by switching, but by not switching our brokerage account. Ka-Ching, how easy was that? Continue reading “We just saved $42,000 by not switching to Betterment”

List of Index ETFs and Mutual Funds

A list of (relatively) low cost index ETFs and mutual funds, their tickers, benchmark index, provider, current fee and yield (as of 12/31/2015 in most cases), dividend payment schedule and link to the fund fact sheet. I haven’t ascertained the dividend schedule for most of the funds yet. Continue reading “List of Index ETFs and Mutual Funds”