Preparing Your Portfolio for 2018

However you want to define it—“smart beta,” factor investing or “enhanced indexing”—Vanguard is stepping onto the playing field. This week, Vanguard announced plans to debut a line of actively managed exchange-traded fundsA type of security which allows investors to indirectly invest in an underlying basket of financial instruments (these may include stocks, bonds, commodities or other types of instruments). Shares in an ETF are publicly traded on an exchange, and the price of an ETF’s shares will fluctuate throughout the trading day (traditional mutual funds trade only once a day). For example, one popular ETF tracks the companies in the S&P 500, so buying a share of the ETF gets an investor exposure to all 500 companies in the index. (ETFs)A type of security which allows investors to indirectly invest in an underlying basket of financial instruments (these may include stocks, bonds, commodities or other types of instruments). Shares in an ETF are publicly traded on an exchange, and the price of an ETF’s shares will fluctuate throughout the trading day (traditional mutual funds trade only once a day). For example, one popular ETF tracks the companies in the S&P 500, so buying a share of the ETF gets an investor exposure to all 500 companies in the index. in the U.S., nearly two years after testing the popularity of such products in the U.K., as we reported in December 2015.

The funds will follow a rules-based, active approach to targeting specific well-known market factors. Vanguard claims they can be used as a substitute for more expensive actively managed mutual funds. But while the Malvern fund giant may call them factor ETFs, that’s really just a window dressing for what they really are: Actively managed funds by a different name.

As a refresher, “smart beta” or “factor” funds function with one foot in both active and passive management. Instead of selecting stocksA financial instrument giving the holder a proportion of the ownership and earnings of a company. by market cap (e.g. large, small) or sector (e.g. energy, technology), they are rules-based on factors such as sales growth, dividendA cash payment to investors who own stock in the company. payouts, price momentum and lower valuations, which can be used to screen a universe of stocks for those with the specific factor or factors desired for a given strategy. Therein lies the “active” element, as the quantitative models that underlie the strategies are tweaked by the funds’ portfolio managers over time.

That said, “factor investing” is simply a new catchphrase for the types of categorizations and investing that index and active managers and investors have been using for decades (“value” is one of the original factors and there have been value investors playing the stockA financial instrument giving the holder a proportion of the ownership and earnings of a company. market since at least the 1920s). The difference today is that greater computing power affords increased capacity and complexity for fund providers to identify these factors and build portfolios based upon them.

Vanguard’s Quantitative EquityThe amount of money that would be returned to shareholders if a company’s assets were sold off and all its debt repaid. Group—led by Antonio Picca and Liqian Ren—will oversee the investments. Vanguard filed for the following “factor products” with the Securities and Exchange Commission (SEC):

• U.S. LiquidityThe ease with which an asset can be bought or sold. Assets for which there are many buyers and sellers at any given time are highly liquid (for example, a stock which trades on a public exchange). Assets which trade rarely are illiquid (for example, a Picasso painting or a high-end home). Factor ETFA type of security which allows investors to indirectly invest in an underlying basket of financial instruments (these may include stocks, bonds, commodities or other types of instruments). Shares in an ETF are publicly traded on an exchange, and the price of an ETF’s shares will fluctuate throughout the trading day (traditional mutual funds trade only once a day). For example, one popular ETF tracks the companies in the S&P 500, so buying a share of the ETF gets an investor exposure to all 500 companies in the index.: Invests in stocks with lower measures of trading liquidityThe ease with which an asset can be bought or sold. Assets for which there are many buyers and sellers at any given time are highly liquid (for example, a stock which trades on a public exchange). Assets which trade rarely are illiquid (for example, a Picasso painting or a high-end home).
• U.S. Minimum VolatilityA measure of how large the changes in an asset’s price are. The more volatile an asset, the more likely that its price will experience sharp rises and steep drops over time. The more volatile an asset is, the riskier it is to invest in. ETF: Seeks capital appreciation with lower volatilityA measure of how large the changes in an asset’s price are. The more volatile an asset, the more likely that its price will experience sharp rises and steep drops over time. The more volatile an asset is, the riskier it is to invest in. relative to the broad U.S. stock market
• U.S. Momentum Factor ETF: Invests in stocks with strong recent performance
• U.S. Quality Factor ETF: Invests in stocks with strong fundamentals
• U.S. Value Factor ETF: Invests in stocks with relatively lower prices relative to fundamental values
• U.S. Multifactor ETF: Invests in stocks with relatively strong recent performance, strong fundamentals and low prices relative to fundamentals. At the outset, this sounds like a combination of the momentum, quality and value strategies listed above into a single portfolio.

The funds are expected to hit the market in mid-February 2018. The Multifactor ETF will also be available as a mutual fund with Admiral class shares, with the ETF and Admiral shares each charging a 0.18% expense ratio. The other factor ETFs are slated to have just the one share class and will cost 0.13%.

That’s significantly cheaper than the PowerShares FTSE RAFI US 1000 ETF, considered by most the original “smart beta” ETF in the U.S., which charges 0.39%.

So is it “smart beta” or simply smart marketing? Time will tell, but at the end of the day, investors are buying factor ETFs in attempts to outperform the market. In our book, that’s an active investment.

With 2018 on the horizon, time is running out to make tax-saving moves in your portfolios. Tax preparation may not be as much fun as holiday shopping or celebrating with friends and family, but it’s your last chance to take the steps that can pay dividendsA cash payment to investors who own stock in the company. next year and beyond. Here are some tips we’ve found valuable over the years for our clients and ourselves:

You’ll typically hear a lot about rebalancing at the beginning of the year in the press and from mutual fund providers. Our take is different.

Conventional wisdom holds that investors should regularly rebalance the funds in their portfolios back to their original allocations. This means selling top performers and reinvesting those proceeds into positions that didn’t put up equally good numbers and have become proportionally underrepresented.

The Adviser Investments team takes a broader view. Unless a portfolio has significantlydiverged from the original allocation, rebalancing is often unnecessary and more work than it’s worth. Our research shows little-to-no performance advantage in automatically rebalancing portfolio allocations every year. And that’s before considering that rebalancing includes costs that can lead to higher tax bills and transaction fees. Doing it now, during the year-end distribution season, could cause your best-laid plans to backfire. Which leads us to…

If you’re planning to buy any mutual funds for the first time or to add to an existing position during the last month of the year, it’s critical to know when those funds will be making their December distribution to avoid paying additional taxes. (In case you missed it, we compiled a list of Vanguard and Fidelity funds’ 2017 distribution dates in the last issue).

As a refresher, if you buy shares of a fund prior to or on its record date (the date on which you must own shares to be eligible for a scheduled distribution), you are also responsible for paying taxes on distributions those shares pay out—even if you didn’t own them when you “earned” that income. But if you do find yourself owing money on distributions, you may be able to offset them by asking…

Nobody likes to see red numbers in the returns column, but those underwater positions aren’t without their own value. If you sell shares at a price below what you paid for them, those losses can be used to offset other gains and income in your portfolio, reducing what you owe Uncle Sam.

Even if you still consider a given fund or position a long-term winner, it’s not like you have to forsake that holding forever. By employing “tax-loss harvesting,” you can sell positions at a loss to offset some of your tax burden, wait at least 30 days and then repurchase the original position (or even more with the money you’ve saved and shares perhaps still cheaper than when you initially bought it).

Why 30 days? The “wash-sale” rule that says you forfeit a tax loss if you make a purchase of the same fund you sold (or a substantially similar fund) 30 days prior to or 30 days after the sale. Also note that the wash-sale rule applies equally to shares acquired through reinvested income—another reason to check and double-check your funds’ distribution dates.

Before using this maneuver, you should confirm that you’re not selling shares of a fund that you can’t replace. For example, if a fund is closed to new investors and you sell your entire position, you won’t be able to buy back in.

If the losses are in a fund you own in a taxable, non-retirement account, you may want to sell shares to avoid a distribution rather than have it add to your tax bill. Before doing so, it’s worth considering the size of the distribution and of your loss, as well as any fees that may be triggered.

These tax discussions are irrelevant for funds owned in tax-deferred retirement accounts such as 401(k)s and IRAs. But for taxable accounts, in addition to tax-loss harvesting, you may also want to consider…

One strategy that we like to use in a number of our clients’ taxable accounts is to put income and capital gains distributions into a money market fund rather than automatically reinvesting the proceeds back into the funds that generated them.

By keeping this cash free, we have the flexibility to reinvest in the fund at a later date or, as part of a rebalancing strategy, use the cash to add to other funds we like that may have had an off year.

For retirement accounts, there are other considerations that can better help you to…

It’s a well-established fact that 401(k)s, IRAs and other retirement vehicles are a great way to keep assets growing at their full, tax-free amounts. Therefore, if you can swing it, always contribute the maximum amounts allowable to each account every year. Depending on your employer’s plan, you may be able to defer up to $18,000 in earnings into a 401(k) or 403(b) account in 2017 (the limit rises to $18,500 in 2018).

If you turn 50 before December 31, 2017, and your plan allows it, you can contribute an additional $6,000 (that limit will be the same next year). As for IRAs, the maximum contribution in 2017 and 2018 is $5,500, plus a “catch-up” contribution of $1,000 for those investors who turn 50 during either calendar year.

For 401(k)s, you have to put your money in by the end of the calendar year, but you have until April 15, 2018, to make your 2017 IRAA type of account in which funds can be saved and invested without being subject to tax until the account holder reaches retirement age. contributions. But sooner is preferable to later, so your tax-deferred money can enjoy as much time in the market compounding gains as possible. But eventually, some is going to have to come out, which brings us to…

If you have certain tax-deferred account types, you are required by law to withdraw a minimum percentage every year once you’ve reached age 70½. You can wait until April 1 of the year following the calendar year in which you cross the 70½-year threshold to take your first distribution. In subsequent years, December 31 is the deadline. It’s confusing, we know.

For non-Roth IRAs and 403(b) accounts, you calculate the RMDA required minimum distribution is the amount of money that must be withdrawn each year from tax-deferred retirement accounts once the beneficiary reaches retirement age (72, according to IRS rules). separately for each account you own, but can withdraw the total amount from one or from multiple accounts. It’s up to you. Unlike IRAs, withdrawals must be taken separately from each 401(k) and 457(b) plan account. Roth IRAs are not subject to RMDs.

Why do we stress the importance of taking RMDs? If you forget to take them, you’re assessed a penalty of 50% of the amount you should have withdrawn, on top of your normal income taxes. That’s a penalty that can really sting, so it’s clearly in your best interest to take this money, something we monitor for our clients every year. After all, that’s what you saved it for.

If you’re in the position where you’re not sure what to do with your RMDs or other savings, you can always consider the personal and financial benefits of…

For those who are interested in making charitable contributions, year-end is a busy time for both donors and recipients. A few guidelines:

• Don’t Cash Out. Give Assets Directly. From a tax standpoint, donating cash is a bad idea. Rather than sending a check or selling assets and donating the proceeds, donating long-term appreciated assets directly to a charity can have tax advantages. You’ll usually get a tax deduction at full, fair-market value, and because you avoid realizing gains (taxed at either your income-tax rate or the long-term capital gains rate), you’ll be donating up to 40% more than by selling the holding yourself and then contributing the proceeds.
• Start Spring Cleaning Early. Donating clothing, furniture and kitchen or office supplies can do more than tidy up your home. By itemizing deductions on items given to charities, you can take a healthy bite out of your tax liabilitiesLiabilities are calculated by adding up your existing debts (mortgage, car loans, student loans, credit cards, etc.)..
• Make the Holidays Green for Others. Feeling generous or want to get into a lower tax bracket? You can give up to $14,000 to as many people as you want without gift tax implications. Couples can give $28,000. You are also allowed to pay tuitions or medical costs of another person if the payment is sent directly to the billing party.
• Pay for Higher Education. 529 college savings plans can be a great way to provide gifts to family members. If you can afford it, you can even circumvent the annual $14,000 gift limit to fund higher learning by using a special rule called “superfunding,” which allows you to contribute up to five times the annual tax-exempted gift limit (so up to $70,000) at once without triggering your lifetime gift or estate tax exclusion. (You can only “superfund” once every five years.) For a married couple, that superfunding could be as much as $140,000, which is certainly a great way to start a newborn on the road to a fully-funded private school, college or graduate school education.

While taxes are one of the last things you may want to think about during the holiday season, taking the time to fine-tune your portfolio now may help prevent bigger headaches and tax bills come April. That said, restructuring a portfolio, moving assets in an attempt to avoid distributions and determining appropriate gift or charitable donations can all be tricky, which is why we recommend you consult with a professional tax or investment adviser before doing so.

About Adviser Investments

Adviser Investments is a full service wealth management firm, offering investment management, financial and tax planning, managed individual bond portfolios, and 401(k) advisory services. We’ve been helping individuals, trustsA legal document that functions as an instruction manual to how you want your money managed and spent in your later years as well as how your assets should be distributed after your death. Assets placed in a trust are generally safe from creditors and can be sold by the trustee in short order, avoiding the lengthy and costly probate process., institutions and foundations since 1994, and have more than 3,500 clients across the country and over $6 billion in assets under management. Our portfolios encompass actively managed funds, ETFs, socially responsible investments and tactical asset allocation strategies, with particular expertise in Fidelity and Vanguard mutual funds. We take pride in being The Adviser You Can Talk To.

Our minimum account size is $350,000.  To see a full list of our awards and recognitions, click here, and for more information, please visit www.adviserinvestments.com or call 800-492-6868.