Comprehensive Advisor

What About Risk and Volatility?

Another issue for ETFs is their affectation for sector investing.  Sector investing tends to be much more volatile than market cap and style investing (think the nine style boxes made famous by Morningstar).  One mantra we live by is low risk.  With the increased risk brought on by sector investing added to active management which also adds risk, then we would have to look very carefully before suggesting anyone use these active ETFs.

 

The reason active management can add risk is the manager has to perform well enough to overcome both the index and the expense ratio of active management.  There are few enough good managers already in existence who can perform this feat for mutual funds.  It’s questionable whether there are any good active managers left for active ETFs.  

 

Another key consideration for this shortage of managers is who is doing the training of these managers.  Remember, these are relatively new funds.  The question we’re forced to ask is, “Are the blind leading the blind?”

 

As always, please visit our website www.weslingfinancial.com or email us at info@weslingfinancial.com for further info and to discuss your personal situation.

What About Track Record?

This is a very good point, because as a relatively new investment category, it’s important to realize that these new categories of active ETFs won’t have terribly long investment records to compare to other investments.

 

Do your homework first.  We recommend clients use funds with at least a five year track record and longer if possible.  With the recent bust and boom and bust cycle of the past nine years, we may start recommending only funds with managers who have been at the helm for much longer periods of time.  For the DIYers, you may want to know where you can look to check the manager’s tenure and the fund’s date of inception.  Investors can find this information by reading the fund’s prospectus that comes out after the end of the latest calendar quarter to get the most recent data.

 

As always, please visit our website www.weslingfinancial.com or email us at info@weslingfinancial.com for further info and to discuss your personal situation.

Can There Be Tax Advantages Using ETFs?

Active ETFs may have better tax advantages because the fund manager can sell the lowest-basis stocks via in-kind stock transfers through the creation and redemption process. This helps systematically reduce the tax exposure for investors.  As with traditional mutual funds, there may be tax consequences later in the year, so stay tuned to the fund.

 

Until ETFs have experience over a number of economic cycles, the analysis for tax advantages will be incomplete.  As with traditional mutual funds, ETFs have had end-of-year distributions, something that wasn’t supposed to happen when ETFs were initially introduced.  So beware of the supposed tax advantages of ETFs until ETFs have been in existence for approximately 15 years, or more.

 

As always, please visit our website www.weslingfinancial.com or email us at info@weslingfinancial.com for further info and to discuss your personal situation.

How About Those Fees?

One of the chief advantages of index-based ETFs was low expense ratios. Actively managed funds generally do cost more. Try and get an idea of what the fee structure will be before you invest.  Compare these fees to similar investments in the mutual fund arena.  Remember, if there is one indicator of how a fund might perform in the future it is low cost, or low expense ratio.  We generally look for funds in the least expensive quartile of the peer group.

 

Further, studies have shown that the expense ratios for ETFs can often be higher than the expense ratios of open-end mutual funds on an apples-to-apples comparison.  For example, a Wall Street Journal study in 2007 showed that on an index-by-index comparison, Vanguard and Fidelity mutual funds had lower expense ratios than the comparable ETFs, in all but one case (in that case it was a tie!).  Also, there are no trading costs for the mutual funds, while the ETFs have trading commissions to buy or sell.  If you’re at one of those full service brokers, the trading commissions can be huge dollars.

 

As always, please visit our website www.weslingfinancial.com or email us at info@weslingfinancial.com for further info and to discuss your personal situation.

How Will ETFs Fit Into My Overall Portfolio?

It may make sense for some investors to look at how ETFs fit into their overall portfolio mix given their particular retirement and investment objectives as well as tax considerations.  We recommend clients look for funds that “stick to their knitting.”  What we mean is that a large blend fund ought to invest in large blend companies, small value funds should be investing in small value companies, and so on across all asset classes chosen for the portfolio.

 

As always, please visit our website www.weslingfinancial.com or email us at info@weslingfinancial.com for further info and to discuss your personal situation.

How Do I Deal With Active ETFs?

Some experts believe as this category develops, the first baby steps for investing will go toward major stocks.  These big companies are generally less volatile and tougher for competitors to mimic the buying strategy, since the companies are so well covered by analysts. Others believe actively managed ETFs will operate with a series of managers whose moves would be tougher to spot on any particular ETF’s disclosure list. As actively managed ETFs evolve, it makes sense to ask some questions which we’ll answer over the next few posts.

 

As always, please visit our website www.weslingfinancial.com or email us at info@weslingfinancial.com for further info and to discuss your personal situation.

Watch Out For Those Ratings!

Yes, the main private investment ratings firms–Moody’s and Standard & Poor’s among them–have been in the doghouse for rating many battered investments highly, not just munis. But most municipals rated AA or AAA may be generally safe to consider. It’s very important to check the issuer’s long-term ratings history. If they’ve been consistently highly ranked over decades and the municipality has no financial scandal (something that can be checked through news archives on the Internet), that’s another good way to research a bond issuer before making a municipal bond purchase.

 

Further, check to see if the rating depends on insurance.  Insurance can prop up a weak bond, but not necessarily save the issuer from default.  If an insurer is exposed to propping up many weak bonds, then the insurer is at risk, and so is your insured bond!

 

As always, please visit our website www.weslingfinancial.com or email us at info@weslingfinancial.com for further info and to discuss your personal situation.

 

Munis Can be Subject to AMT? Is that True?

Yes, some munis can be subject to this tax.  While most munis pay interest that’s free from federal income taxes, some may pay income subject to the alternative minimum tax, or the AMT.  It’s a little more complicated than we have space for here, but this is absolutely why you need to talk to your tax professional or financial planner before making a move into munis.  In any case, beware of "private activity muni bonds."

 

Don’t forget to ladder: “Laddering” is a portfolio structuring term. To ladder bonds means that you are buying them with maturities occurring at regular intervals, so when they mature, you’ll have money to reinvest at those same regular intervals.  Laddering also offers you some portfolio diversification across many parameters including, time, municipality, interest rate, and debt quality.

 

As always, please visit our website www.weslingfinancial.com or email us at info@weslingfinancial.com for further info and to discuss your personal situation.

What Munis Should I Stay Away From?

There are some local governments who issued a hybrid muni known as a variable-rate demand note. These were sold mainly to institutions with maturities of up to 30 years that were paying at rates reset as frequently as once a day. During the crisis, the rates on these notes have shot up to double-digit territory, putting the municipalities that issued them under particular strain due to short-term interest rate adjustments.

 

As always, please visit our website www.weslingfinancial.com or email us at info@weslingfinancial.com for further info and to discuss your personal situation.

Is There Opportunity for You?

Look at some of the highly rated outstanding bonds.  You’ll find some amazing yields you certainly won’t find in CDs and other investments. Even though their prices have plunged, some municipals late last year were offering long-term, tax-free yields of five percent and above, which translate into the equivalent of nearly seven percent for taxpayers in the 28 percent bracket and nearly eight percent for someone in the top 35 percent bracket when the tax exemption is considered. 

That’s a very nice return relative to U.S. Treasuries, considered the safest investments of all.

 

 

But before you buy, here are some things to know and steps to follow.

Are munis right for you? The first call you make shouldn’t be to a broker.  Most brokers will charge both the spread (the difference between the price the broker buys the bond for and the market price) and another hidden fee of up to $30 (or more) for a long term bond.  That’s way too expensive.  Find an investment advisor professional who can buy the municipal bond for you for the amount of the spread, and no additional fees.

 

 

Further, an investment advisor can take a look at your entire taxable investment portfolio to help you understand the taxable versus the non-taxable yield.  And remember, there’s no point in putting tax-exempt munis into tax-exempt accounts like IRAs or 401(k)s; it’s actually against the rules.  As an aside, this same principal applies to tax-deferred annuities, yet, every stock broker and insurance agent in town loves to have people buy tax-deferred annuities for their IRAs.  Talk about ripping off the clients!

 

 

Also, be sure to determine whether the bonds you’re buying are highly rated or not.  Look out for insured bonds.  Insured bonds may have higher ratings due to the insurance.  The insurance suggests the bond is actually a weaker investment and one you should think twice about before purchasing.  A bit contrarian, I know.

 

 

As always, please visit our website www.weslingfinancial.com or email us at info@weslingfinancial.com for further info and to discuss your personal situation.