What I'm Doing as an Investor During the Financial Crisis

As the economy has turned south, I've been asked if I think it is a good time to cut back on retirement plan contributions. A friend recently moved all his retirement account investments into bonds. Investors pulled out of mutual funds in September in greater numbers than in any time in the history of the mutual fund industry. What is an investor to do?

I have a long time horizon until retirement, and I can leave my taxable investments in the market for a while. So I am following Warren Buffet's lead and am buying.

I'm doing four things.

1) I'm re-balancing my retirement account to be 100% Equities and increasing my small cap growth and large cap value investments.


I was already 90% invested in equities so this is not a huge change. I moved out of bond funds, which have certainly cushioned the decline in my retirement account. And I'm moving funds from an S&P 500 index fund into Dodge and Cox, a Large Cap Value managed fund. I have many years to go before I retire so even if markets decline further, I think being 100% in equities after 30-40% declines year to date, is a good plan for the long term.

2) I'm increasing my contribution to my employer based retirement plan (see above) from 13% of my salary to 16%. This is also not a huge change, but the more money I can invest while the markets are down significantly, the better.

3) I'm going through my taxable account, and looking for funds that I can sell at a significant loss. I will immediately reinvest in another fund in the same category, as I feel good about the asset allocation in my taxable account. But by selling at a loss and reinvesting, I maintain the same exposure to equities, I have a chance to replace funds that are not performing in line with peers in their categories, and I get to offset the loss against my income come tax day! I'll write a post with details about this soon.

4) I'm looking for cash to invest. Since I'm increasing my retirement contributions, my pay check will decline slightly. I have an emergency fund and though I already live comfortably below my means, there are ways I can cut back and save even more. So I'm looking to see if I can find cash to invest without depleting my emergency fund. More about this soon as well!

Reinvesting dividends and capital gains in a taxable account

Up until now, I had all my mutual fund dividends and capital gains distributions set to automatically reinvest in my taxable brokerage account.

This creates a bit of work when it comes to calculating the basis on my holdings when I sell a fund, but I don't mind. And with online brokerages, it is not much work at all. Etrade keeps track of the basis and I assume other brokerages do too. So as long as I note the basis before I sell and the holding no longer shows in my portfolio, and the records are accurate for holdings I bought before I started using Etrade, there is no work to do at all.

There are four reasons I turned off automatic dividend reinvesting, anyway:

1) If you sell a no-load no-fee fund within 90 days of purchase you are penalized a fee of $49.99. I do not know that this applies to automatic reinvestments (I assume it does), but I'd rather not worry or risk the hassle.

2) If I think I want to sell a fund, I typically don't add anything to it for a year before I sell so any gains are taxed as long term gains. I have two funds I have not been adding to since last June, thinking I might sell after my last addition to the funds is a year ago or greater. In December the funds distributed and reinvested automatically. This complicates the tax implications of a sale unless I now wait until next December which has slightly agitated my calm.

3) I invest regularly adding small amounts to some holdings to keep my overall portfolio balanced as I want it. Taking gains and distributions as cash and manually adding them to the funds I want to gives me more control over keeping my overall portfolio in balance. For some people (those who would let the cash sit) this might not be a good idea, but I have seen that I regularly take the cash I save in my brokerage and invest it, so this should work well for me.

4) Even though Etrade keeps good records of all my purchases, when Etrade bought my previous brokerage, the old electronic details did not convert over. I assume if Etrade goes under or another firm buys Etrade, or I end up with a new brokerage for any reason, the balances will transfer but the details about my basis will not. Sure I can keep track of everything myself, but to do so is more hassle than it is worth.

If you have an Etrade account that is not a retirement account, or even if it is a retirement account, and you want to un-enroll from automatic reinvesting, simply go to the online service center and type in a request to customer service for them to make the change. For mutual funds, you cannot do it yourself through their interface.

I left my Roth IRA alone so it still automatically reinvests. Since I only add to the IRA once a year, and I cannot add enough to rebalance all the holdings by adding to the market sectors that trailed the year before, and I don't have enough in the IRA for the dividends and distributions to be significant, and the IRA is not taxed like a non-retirement account, it make sense to me to allow the dividends to reinvest.

On an unrelated note, check out the Coyote I saw romping around in the snow in my driveway the other day!

Portfolio Update: 12/14/07 Capital Gains Bring Sadness

Ever look up your fund's daily performance and find it is down 10, even 12%? Every so often, a market will collapse, but when a market is down 1- 1/2% but your fund, which invests in a number of stocks in that market, is down 10% for the day, the cause is almost always... Capital Gains Distributions.

Look below at Friday's one day change for JAOSX Janus Overseas and and JAGIX Janus Growth and Income. Since I own both these funds, I am experiencing a little bit of the sadness about the taxes I will owe. Ok, the sadness has past. It is hard to feel too sad about paying taxes on 12% of a fund that has returned over 26% this year alone (JAOSX)!

Anyway, the daily numbers on several of the portfolios below are all over the place as distributions are made and I hypothetically reinvest them.


Despite that, and the recent slate of down days, the trends in the portfolios are continuing. The Three Fund Index continues to inch closer to first and the last place S&P 500 remains in last place but continues to post the best one week results.

WylieMoney 20 Mostly Managed

Three Fund Index

Lazy 20 Mostly Index

WylieMoney Slowly

ETF 20

S&P 500

What is this thing called "Mutual Fund Turnover?"

oneopinion left a comment and asks: "...why is high turnover a negative in a mutual fund and why do you set a turnover rate of 100% as the maximum?"

Thanks for the question. First, let me clarify, I did not set 100% as a maximum, and I do not have a maximum for new picks for my hypothetical portfolios. I do, however, prefer low turnover so lower expenses or much better long term performance would be necessary for me to choose a fund with high turnover over a comparable choice.

The question was why?

The hypothetical portfolios I have been tracking are for a non-retirement account so any capital gains would result in hypothetical taxes owed and higher turnover is more likely to lead to more capital gains

Morningstar.com defines turnover ratio:

"This is a measure of the fund's trading activity, which is computed by taking the lesser of purchases or sales (excluding all securities with maturities of less than one year) and dividing by average monthly net assets. A turnover ratio of 100% or more does not necessarily suggest that all securities in the portfolio have been traded. In practical terms, the resulting percentage loosely represents the percentage of the portfolio's holdings that have changed over the past year. A low turnover figure (20% to 30%) would indicate a buy-and-hold strategy. High turnover (more than 100%) would indicate an investment strategy involving considerable buying and selling of securities. Morningstar does not calculate turnover ratios. The figure is culled directly from the financial highlights of the fund's annual report."

The Motley Fool sums it up thusly:

"Turnover Rate and Taxes. A fund's turnover rate basically represents the percentage of a fund's holdings that it changes every year. A managed mutual fund has an average turnover rate of approximately 85%, meaning that funds are selling most of their holdings every year. Because buying and selling stocks costs money through commissions and spreads, a high turnover indicates higher costs (and lower shareholder returns) for the fund. Also, funds that have large turnover ratios will end up distributing yearly capital gains to their shareholders. Shareholders will have to pay taxes on these gains, and paying these taxes can be a real killer. Keep an eye on the turnover rate of any fund you own, and look to own funds with low (preferably no higher than 25%) turnover rates. (Index fund turnover is around 5% or lower.)"

Emphasis added.

I have no idea why fool.com claims that index fund turnover is 5% or lower. In my portfolios of index funds and ETFs almost all the funds have turnover much higher than 5%.

Take VIGRX Vanguard growth index. It has a turnover ratio of 28%. Not bad, but nowhere close to 5%.

Index portfolios recovering quicker but...

...they have a way to go yet. WylieMoney is still in the lead.


When I put together a portfolio of 20 funds, one fund in each of 20 different fund categories, and then picked the 20 Vanguard Index funds that covered the same 20 categories and started tracking their performance, I assumed the hand picked funds would not keep up. I also assumed that the index funds would be better from a capital gain/ tax perspective. So both assumptions, have turned out wrong.

I limited myself so the funds I picked are not the best funds out there. My criteria:
* Open to new investors
* Available through one brokerage (I used Etrade)
* Had to be a NTF- No Transaction Fee fund. So no fees, no loads.
* An initial investment minimum of $2500 or less
* A subsequent AIP investment minimum no greater then $100

Some of my best choices are rated 2-3 stars (ACFFX for example). But during the recent assault...

...my WylieMoney portfolio wupped up on the "Lazy Vanguard Index Portfolio" like nobody's business.

I picked an equally weighted portfolio of three Vanguard total market funds covering Domestic and International Stocks and bonds in equal weight by category of the 20 fund portfolios and it has fared better than the 20 Vanguard funds, but WylieMoney is still in the lead. At least it is back above $50,000!


Over the last two days, the WylieMoney portfolio has not risen as much as the Vanguard portfolios, but it remains ahead. When the markets tanked, the index portfolios really suffered.

More surprising to me was the realization that Morningstar shows that the WylieMoney portfolio has 11.96% Potential Capital gains exposure and a 35.85% Average Turnover Ratio compared to the Lazy 20 which has a higher Potential Capital Gains exposure of 15.13% and a Turnover Ratio of 36.20%. And the 3 index fund portfolio has a Potential Capital Gains Exposure of 20.83% with a lower 12.35% Turnover Ratio. Since I was thinking of this as a non-retirement account- that makes a difference.

I admit I do not understand in great detail all the complexities of how to accurately assess tax impacts of all the individual funds- international funds, REITs, etc all of which are in these portfolios. But if portfolios turn over a lot- meaning the fund managers are selling stocks and buying different stocks more often, and the capital gains exposure is high, meaning tax is owed on profits, then when the taxman comes, you take a larger hit.

And everything I have read in the press has led me to believe that index investing is MUCH more tax efficient than picking a bunch of low (relatively low!) barrier to entry managed funds.

So all in all, a good week. Plus, I saw the Police at Fenway Park last Sunday!


The details (click for a larger view):

What investment records should you keep?

Keep them all.

Lots of financial sites and blogs post articles offering advice about what records to keep in general: bankrate, soundmoneytips, realsimple, even the IRS has made an attempt.

As is often the case, Morningstar has one of the best explanations for why this matters when it comes to investment records.

I keep every monthly statement from my brokerage and have a file over 2 1/2 inches deep to show for it. I wish this was an indicator of massive wealth, but really it is just a symptom of reinvested dividends.


If you put $500 in a growth and income fund and reinvest the dividends and capital gains, each payment- in cents, dollars, whatever, is a transaction on the statement. And at the end of the year, you pay income taxes on those payments, even though they are (re)invested, and not cash in your pocketses. So if you do not have a ton of money (yet!), but still want to diversify broadly and put a small amount of money in a number of funds instead of just piling it all into one, your statements get long.

Some of the new retirement funds like Vanguard Target Retirement 2050 are actually a collection of funds, so you can put all or some of your money in one of these, even if you do not plan to save it until retirement, and diversify that way, but I digress

Some brokerages are no longer sending paper statements automatically and actually charging investors for this 'privilege.' Here is Ameritrade, disclosing its fees:

So if you only get electronic statements, or opt to get electronic only, you have to keep those too. And back them up!

I finally got my 3rd and 4th brokerage account tax statements. One of these adjustments changed how $22.46 was allocated for tax purposes. I waited a month and a half to file my taxes because of how $22... good grief.

So anyway, I sold a fund last year and I knew how much I originally invested, and Etrade does a good job of keeping track of funds that have automatically reinvested since they bought my account from my previous brokerage. My old records, however, did not convert to my Etrade account so I had to go back through my paper records starting in 2000 when I bought the fund to calculate my actual basis. This took me about 3 minutes to do because I had all my records in order and this changed my basis by a couple of hundred dollars which lowered my tax bill enough to buy a decent bottle of wine! Or, if I shop at Trader Joe's, 3 or 4 decent bottles of wine!

So the lesson here is that you should keep your statements, paper or electronic, because your brokerage may be bought by a competing brokerage, or it may raise its fees and you may transfer your account to a better brokerage and all your details may not transfer over. And unless you want to pay the tax man (or woman) for the same profits twice, you'll want to be able to add up your actual basis, not just the amount you originally invested and having your statements handy and organized makes this pretty easy.

Where are the charts?

A friend and faithful Wylie Money reader asked me- "Where are your charts? Your Graphs? The track record of your hypothetical portfolio as it takes the S&P 500 and thrashes it soundly, beating it into the ground?"

I started on a long post about how there is no free portfolio tracking tool that automatically re-invests dividends and capital gains pay-outs especially from a historical date and I have not found a good tool to allow me to do this manually for the 20 funds I plan to track...

Then I started thinking about my friend and his question and I got bitter and decided that he just wanted charts because his brain has frozen solid and gone numb because of all the snow he has suffered through recently (he lives in Denver).

Then I realized, yea... I need some charts. But it could be a bit tedious to manage so here is my plan:

I will chart the investment of $2500 per fund in each fund with $100 additional contributions on specific days I will pick each month (more about this process later). I am starting with a minimum of $2500 because several of the funds I have picked so far require this much and none of the funds I have picked (or will pick) require more than this- so one could actually follow this plan. Same reasoning behind the subsequent $100 additions.

I will do this one of 2 ways. I will pick about 20 funds total and either:

a) One of you can give me $50,000 and $2000 per month- which is the cost of investing in this entire portfolio and I will invest it and etrade can re-invest the distributions and capital gains!!!!!

or

b) I will set up a hypothetical portfolio- in Morningstar but please post a comment if you know of an easier to use free portfolio tool. And I will try and keep track of reinvesting dividends, etc. manually which will be tedious and make me sad.

or

c) I will just set up a portfolio to track daily NAV (prices) which will give a general sense of earnings and be less tedious.

Final note- until I pick all 20 funds, I will not set this up because going back and trying to get historical info and tracking the funds and picking new ones all at once would require more time spent on this that I am willing to commit.

Capital Gains Distributions Attack!

So December 4th was a good day for investors as the DOW, NASDAQ and S&P 500 were all up over +0.70%.




Two funds caught my eye yesterday as they posted serious declines in value (images from cnn.com):

PCOAX Putnam Capital Opportunities;A






PGRWX Putnam Growth & Income;A






So what gives? Many mutual funds make capital gains distributions. Often this is a result of portfolio turnover. Wikipeda explains it like this:

"Turnover generally has tax consequences for a fund, which are passed through to investors. In particular, when selling an investment from its portfolio, a fund may realize a capital gain, which will ultimately be distributed to investors as taxable income."

Someone holding the funds above would not see the total value of their holdings go down by 10% or 11%, assuming they were reinvesting their dividends and capital gains distributions, as the amount of the distribution would buy additional (now cheaper) shares of the fund.

Where this shows up is in the new year, when it comes times to pay taxes. The 10% that was distributed will show up on Form 1099-DIV from your brokerage as a taxable event. So you will owe taxes on the amount distributed.

One way to avoid or lessen the amount of capital gains distributions you receive is to invest in funds that do not sell the stocks they own very frequently- funds with lower turnover. In retirement accounts, IRAs 401(k)s or 403(b)s for example, your holds are not subject to taxes while they are held in the account so you do not pay taxes on these distributions. Kep in mind though that when a fund manager sells a stock, she pays a fee to do so, just like you would, and those fees are also passed on to shareholders so low turnover is good for a variety of reasons, even in tax free or tax deferred accounts.

That said, you will find that different strategies are used in categories- some categories have higher average turnover than others. The key here is not to pick the lowest turnover possible- if the fund is underperforming its peers for example. A better strategy is to pick a well performing fund with a lower than average turnover.

The Putnam Capital Opportunities fund Is a Small Cap Growth fund with 60.27% turnover. This is high, but the average for this category is 110.43% so this is below average. The bigger concern here is the 5.25% sales load. If you bought this fund at the beginning of the year and sold it on October 31st, you might be pleased with your anticipated windfall as the fund was up 13.09% at that point. The average gain for funds in this category was only 7.16%. However, after paying the 5.25% sales load, accounting for 1.20% in expenses and after paying taxes on profit and capital gains, the estimated take home here is 4.65%.










The Putnam Growth and Income fund is a different story with some similar issues. The first issue here is that, despite the name, this fund falls in the Large Cap Value category not the Large Cap Growth category. Funds do drift around and switch categories from time to time, but this fund has been solidly Value for a while:












Why does this matter? You should know what you have. Different sectors go in and out of favor. A lot of analysts think Large growth stocks are due for a run. If you owned this fund, you might think you have your investments poised to take advantage of this trend if it happens. You would be wrong and Putnam should be ashamed for misleading you or better yet, update the name of the fund. Anyway...

The average turnover for Large Cap Value funds is 55.91% and the average for Large Cap Growth is 83.76%. Since this fund is invested in Value stocks its turnover at 52.80% is... average. If you bought this at the beginning of the year and sold it at the end of Oct. you would not walk away with a 10.99% increase- you would take home around 3.34%.










When we choose a Large Cap Value fund for out hypothetical non-retirement account, we'll see if we can find a fund with lower turnover, and hopefully now it is a little more clear why we care!