Tag Archives: capital-gains

How Can I Pick The Best Dividend ETF?

Summary Dividend ETFs are tools for building a better retirement. Finding the right exchange traded fund for an individual investor requires knowing how the investor wants to use the tool. Investors that want to dollar-cost average into the ETF will need to consider the impact of trading costs. When an investor is looking at the dividend yield, they need to calculate the yield across the entire portfolio. Investors should aim to have a healthy margin of safety to facilitate a buy-and-hold strategy. Many investors have recognized that they need to create a dividend portfolio with strong yields and low risks to protect their lifestyle in retirement. ETFs with strong dividend yields are the quickest way that investors can get access to a diversified group of high dividend companies that will provide a growing stream of income for them to live on without having to use up the principle. Drawing down the portfolio eventually leads to a death clock as investors are forced to wonder if they will outlive their money. Building a portfolio around a high-quality ETF is one way to prepare for a long and happy retirement. It Starts With You When you want to find the right dividend ETF, you need to recognize that you are looking for a financial tool. Remembering that the ETF is simply one tool will make it easier to find the best one for you. There are certain factors that will always be important, but the importance of each factor depends on the investor. Buying Strategy Are you making one lump purchase, or are you planning to dollar-cost average into the position over time? The answer is very important, because it determines which aspects of the investment will be most important in analyzing your long-term costs of owning the tool. If you intend to buy all of your shares this month with a large pile of cash, then trading commissions (generally under $10) will be largely irrelevant. On the other hand, if you are planning for a retirement in 20 years and intend to dollar-cost average into the ETF by buying once every week, every two weeks, or each month, trading commissions will be an important consideration. If you fall into the category of frequently making small purchases, then you will want to either prioritize ETFs you can trade for free from your current brokerage, or consider changing brokerages if necessary. Personally, I fall into this category. On average I make about three acquisitions a month through various accounts. I hardly ever sell a high-quality ETF, but I like to be able to make small purchases on a consistent basis. Expense Ratios The expense ratio is a very important factor for the long-term investor. If you follow the simple “buy and hold” strategy, which I endorse, the expense ratio can become a big deal when your holding period stretches from a few years to decades. If you are holding these funds in a taxable account, selling one ETF to buy a different one could incur capital gains taxes. Therefore, I prefer larger funds with a solid history of operating at low costs. In general, expense ratios less than 0.25% are reasonable, and ratios less than 0.13% are excellent. Net or Gross The net expense ratio is what investors actually give up from the fund each year. Some advisors will say that the net expense ratio is the only one that matters, but the gross expense ratio gives investors an idea of where expense ratios might go in the future. If you’re buying an ETF with a low net expense ratio and a high gross expense ratio, it would be better to have the fund in a tax advantaged account so you can change ETFs if the ratio changes significantly. Liquidity and Spreads If you’re going to buy shares in exchange traded fund, you should look into the liquidity and the spread. In general higher levels of liquidity and lower spreads will occur together. A large spread is like an increase in the trading commissions because it will increase your effective costs for each share you buy or sell. So long as the spread is regularly very small, weaker liquidity might not seem like a problem. If the investor is certain they will not need access to the principle at any point, then the weaker liquidity shouldn’t be too much of an issue. On the other hand, if you are not fully insured and might suddenly need access to a large amount of cash, it would be unwise to choose an ETF with poor liquidity. Dividend Yields and the Margin of Safety When you’re buying a dividend ETF, one of the first things you need to ask is whether the dividend yield is going to be sufficient for your needs. When an investor buys into the fund, they should be looking at the dividend yield on their entire portfolio. If the investor is wisely including treasury securities as part of their portfolio, they may have a weaker portfolio yield. Since the ETF will be a major source of income, investors may want to use it as a core piece of their portfolio and allocate between 25% and 60% of their wealth to the ETF. Therefore, they should look at the dividend yield on the ETF. However, simply looking at the number listed for “dividend yield” is insufficient. Investors should pull up the “dividend history”. When investors look at the dividend history, they should consider whether the fund pays monthly or quarterly. If the fund pays quarterly, do you feel comfortable managing your living expenses on a 3 month period rather than monthly? The next factor is looking at the dividends to determine if they have been cut on an annual basis at some point. If the fund has a long track record, investors can see how the fund performed during 2007. Remember that the goal of buying a high quality income ETF is being able to have a steady source of income without listening to the news. If dividends are cut during a recession, investors may be forced to “create dividends” by selling off shares. Under Modern Portfolio Theory selling shares is a perfectly acceptable way to generate extra dividends. Under Behavioral Portfolio Theory, the reality is that human psychology encourages the investor to sell off too many shares at the bottom of the correction. Margin of Safety When an investor is determining the yield they need from their investment to create a strong enough portfolio yield to cover their living expenses, they should ensure that there is a healthy margin of safety. Whether the dividend cut comes from the ETF or from other holdings in the portfolio, the investor needs enough income to know they can cover their expenses without being kept awake at night worrying about their portfolio. The more volatile the dividend history of the ETF, the larger the margin of safety should be. Investors using BDCs (Business Development Companies) or mREITs to strengthen their portfolio yield will need a larger margin of safety because those sectors have dramatically more dividend risk than a high quality dividend ETF.

What The 3rd Quarter Tells Us About The Stock Market In October

As things currently stand, investments that are more likely to benefit from lower borrowing costs rather than higher ones have been winners. The demand for higher yielding stocks contradicts the idea that the Federal Reserve can demonstrate any genuine conviction when attempting to move the overnight lending rate higher. Relative strength for utilities and REITs in the stock world, as well as relative strength for investment grade debt in the bond universe, suggest that the Fed will barely bump overnight lending rates, if at all. Three months ago to the day (6/30), I served up a list of reasons for lowering one’s exposure to riskier assets . I discussed weakness in market internals where fewer and fewer corporate components of the Dow and S&P 500 had been propping up the popular U.S. benchmarks. I talked about the faster rate of deterioration in foreign stocks over domestic stocks via the Vanguard FTSE All-World ex-US ETF (NYSEARCA: VEU ):S PDR S&P 500 Trust ETF (NYSEARCA: SPY ) price ratio. Additionally, I highlighted exorbitant U.S. stock valuations, the Federal Reserve’s rate hike quagmire and the ominous risk aversion in credit spreads. Three months later (9/30), a wide variety of risk assets are trading near 52-week lows or near year-to-date lows. Higher yielding bonds via the PIMCO 0-5 Year High Yield Corporate Bond Index ETF (NYSEARCA: HYS ) as well as the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA: HYG ) are floundering in the basement. Energy via the Guggenheim S&P Equal Weight Energy ETF (NYSEARCA: RYE ) has broken down below the S&P 500’s correction lows of August 24, suggesting that a bounce in oil and gas may be premature. Even former leadership in the beloved biotech sector via the SPDR Biotech ETF (NYSEARCA: XBI ) reminds us that bearish drops of 33% can destroy wealth as quickly as it is accumulated. Is it true that, historically speaking, bull market rallies typically fend off 10%-19% pullbacks? Absolutely. Yet there is nothing typical about zero percent rate policy for roughly seven years. For that matter, there was nothing normal about the U.S. Federal Reserve’s quantitative easing experiment – an emergency endeavor where $3.75 trillion in electronic dollar credits were used to acquire government debt and mortgage-backed debt. And ever since its 3rd iteration came to an end eleven months ago, broad market index investments like the Vanguard Total Stock Market ETF (NYSEARCA: VTI ) have lost ground. The same thing happened in 2010 during “QE1.” Once it ended, risk assets had lost their mojo. Then in September of 2010, rumors swirled about the Fed engaging in a second round of quantitative easing (a.k.a. “QE2″). And then the bull rally was back in business. As things currently stand, investments that are more likely to benefit from lower borrowing costs rather than higher ones have been winners. Utilities and REITs are up over the last three months; in contrast, industrials, financials and retail have been battered. The demand for higher yielding stocks contradicts the idea that the Federal Reserve can demonstrate any genuine conviction when attempting to move the overnight lending rate higher. (Some seem to believe that the next significant move might even be to ease.) Relative strength for utilities and REITs in the stock world, as well as relative strength for investment grade debt in the bond universe, suggest that the Fed will barely bump overnight lending rates, if at all. Granted, the Federal Reserve would like to tell you the job growth is solid, even as chairwoman Yellen and her colleagues ignore the disappearance of high-paying manufacturing jobs on a daily basis. It has gotten so bad that, according to ADP, the manufacturing sector has experienced a net LOSS for 2015. Is it any wonder that the extraordinary growth of part-time service workers alongside the loss of full-time manufacturing positions have contributed to significant declines in median household income? Should we ignore the reality that 19.5% of the 25-54 year-old, working-aged population is not participating in the labor force (a.k.a. unemployed) – a percentage that has increased every year from 16.5% in the Great Recession to 19.5% today? These are not “retirees” that we’re talking about here. We are maintaining our lower-than-normal asset allocation for our moderate growth and income clients at Pacific Park Financial, Inc. During June-July, our equity exposure moved down from 65%-70% stock (e.g., growth, value, large, small, foreign, etc.), down to 50% (mostly large-cap domestic). Our income exposure moved down from 30%-35% (e.g., short, long, investment grade, high yield, etc.) down to 25% (almost exclusively investment grade). The 25% cash component that we’ve been holding? We would need to see a desire for greater risk through greater pursuit of high yield bonds at the expense of treasuries. We would want to see a pursuit of capital gains over safety in a rising price ratio for the PowerShares S&P 500 High Beta Portfolio ETF (NYSEARCA: SPHB ):iShares MSCI USA Minimum Volatility ETF (NYSEARCA: USMV ). The fact that the SPHB:USMV price ratio is near its lows for the year tells me that it is still better to be safe than sorrowful. Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.

USMV: It Lives Up To The Name, This Is One Durable Fund

Summary USMV offers investors fairly low volatility and a low beta that make it easy to fit into a portfolio. The holdings start with a heavy position in telecommunications, but less than 5% of the portfolio is in the sector. The exposure to consumer staples, health care, and utilities look nice. Having seen USMV get hit by the absurd sell off on 8/24/2015, investors should avoid using stop loss orders. Investors should be seeking to improve their risk adjusted returns. I’m a big fan of using ETFs to achieve the risk adjusted returns relative to the portfolios that a normal investor can generate for themselves after trading costs. I’m working on building a new portfolio and I’m going to be analyzing several of the ETFs that I am considering for my personal portfolio. One of the funds that I’m considering is the iShares MSCI USA Minimum Volatility ETF (NYSEARCA: USMV ). I’ll be performing a substantial portion of my analysis along the lines of modern portfolio theory, so my goal is to find ways to minimize costs while achieving diversification to reduce my risk level. Expense Ratio The expense ratio on USMV is .15%. It isn’t as cheap as many of the Schwab or Vanguard funds, but this is still well within reason for an investor trying to control the amount of their wealth that flows out to expense ratios each year. Largest Holdings The iShares MSCI USA Minimum Volatility ETF has a fairly diversified group of holdings. When I pulled the numbers nothing was over 1.7% of the portfolio. This internal diversification is great for reducing any idiosyncratic risk from concentrated positions. Looking through the portfolio investors may notice that there appears to be a bias towards companies that pay high dividends. Since those companies are rapidly returning money to shareholders, they have an easier time maintaining a solid valuation since their values are tied to dividends that are more predictable than future growth which may require more estimation. I’ve been fairly bearish on telecommunications since it became clear Sprint (NYSE: S ) intended to create a price war that I expected to drag down profits for AT&T (NYSE: T ) and Verizon (NYSE: VZ ). However, these are huge companies with a long track record, high dividend yield, and solid business model. I’m not completely sold on them, but with the level of diversification in the portfolio I don’t see it as a big problem. If they were combining to be 10 to 15% of the portfolio, I wouldn’t find USMV so attractive. Sectors The following chart breaks down the sector holdings for the fund. The first thing I was checking was for any other exposure to telecommunications. While there are two major telecommunications firms in the top 3 holdings, the total weight in the portfolio is only 4.23% which reassures me that the portfolio wouldn’t be heavily exposed to the price based competition in the telecommunication arena. On the other hand we do see some solid weights for healthcare, consumer staples, and utilities. These are three sectors that I expect to have very solid demand over the next decade. These sectors are simply very hard to replace. Even if we see substantial changes in the economy as technology changes, these sectors remain highly relevant due to the impacts of an aging population, a need for basic supplies, and a desire to keep our homes heated (or cooled). Building the Portfolio This hypothetical portfolio has a slightly aggressive allocation for the middle aged investor. Only 30% of the total portfolio value is placed in bonds and a third of that bond allocation is given to emerging market bonds. However, another 10% of the portfolio is given to preferred shares and 10% is given to a minimum volatility fund that has proven to be fairly stable. Within the bond portfolio, the portion of bonds that are not from emerging markets are high quality medium term treasury securities that show a negative correlation to most equity assets. The result is a portfolio that is substantially less volatile than what most investors would build for themselves. For a younger investor with a high risk tolerance this may be significantly more conservative than they would need. The portfolio assumes frequent rebalancing which would be a problem for short term trading outside of tax advantaged accounts unless the investor was going to rebalance by adding to their positions on a regular basis and allocating the majority of the capital towards whichever portions of the portfolio had been underperforming recently. (click to enlarge) A quick rundown of the portfolio The two bond funds in the portfolio are the iShares J.P. Morgan USD Emerging Markets Bond ETF (EBM) for higher yielding debt from emerging markets and for medium term treasury debt. The iShares 7-10 Year Treasury Bond ETF (NYSEARCA: IEF ) should be useful for the highly negative correlation it provides relative to the equity positions. EMB on the other hand is attempting to produce more current income with less duration risk by taking on some risk from investing in emerging markets. The iShares U.S. Preferred Stock ETF (NYSEARCA: PFF ) gives investors a respectable current yield in a period of very weak interest rates. The position in the iShares MSCI USA Minimum Volatility ETF offers investors substantially lower volatility with a beta of only .7 which makes the fund an excellent fit for many investors. It won’t climb as fast as the rest of the market, but it also does better at resisting drawdowns. It may not be “exciting”, but there are plenty of other areas to find “excitement” in life. Wondering if your retirement account is going to implode should not be a source of excitement. The position in the PowerShares Buyback Achievers Portfolio ETF (NYSEARCA: PKW ) makes the portfolio overweight on companies that are performing buybacks. The strategy has produced surprisingly solid returns over the sample period. I wouldn’t normally consider this as a necessary exposure for investors, but it seemed like an interesting one to include and with a very high correlation to the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) and similar levels of volatility it has little impact on the numbers for the rest of the portfolio. The core of the portfolio comes from simple exposure to the S&P 500 via SPY, though I would suggest that investors creating a new portfolio and not tied into an ETF for that large domestic position should consider the alternative by Vanguard’s Vanguard S&P 500 ETF (NYSEARCA: VOO ) which offers similar holdings and a lower expense ratio. I have yet to see any good argument for not using or another very similar fund as the core of a portfolio. In this piece I’m using SPY because some investors with a very long history of selling SPY may not want to trigger the capital gains tax on selling the position and thus choose to continue holding SPY rather than the alternatives with lower expense ratios. Risk Contribution The risk contribution category demonstrates the amount of the portfolio’s volatility that can be attributed to that position. To make it easier to analyze how risky each holding would be in the context of the portfolio, I have most of these holdings weighted at a simple 10%. Because of IEF’s heavy negative correlation, it receives a weighting of 20%. Since SPY is used as the core of the portfolio, it merits a weighting of 40%. Correlation The chart below shows the correlation of each ETF with each other ETF in the portfolio and with the S&P 500 . Blue boxes indicate positive correlations and tan box indicate negative correlations. Generally speaking lower levels of correlation are highly desirable and high levels of correlation substantially reduce the benefits from diversification. Conclusion The USMV fund has a solid correlation to the S&P 500, coming in around 90%, but the low annualized volatility allows it to achieve a beta of only .69 which makes the required returns on the ETF substantially lower than the required returns on pure equity positions. While the performance of the portfolio trailed the S&P 500 and may regularly trail it, it is also more resilient to selling pressure. Perhaps there should be one caveat stated. During the panic on 8/24/2015 the ETF sold off dramatically and hit an absurd low of $26.41 before bouncing back to close at $39.25. The biggest message there is that investors seeking stability may want to look at USMV, but they shouldn’t be eager to put in stop losses. During the selling that impacted many stocks and ETFs, USMV was not immune to the sudden and absurd price drop. Simply using USMV as a large allocation should be enough to materially decrease portfolio risk. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.