Archives for October 2016

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Evaluating the Vanguard International High Dividend Yield Index Fund

Quick housekeeping note: My wife and I are in the middle of a move from Colorado to St. Louis. As a result of that and a minor medical issue (nothing to worry about, but it’s taking up a fair bit of time), there will be no articles until Monday 11/7, at which point the publishing schedule will resume as normal.

A reader writes in, asking:

“Have you looked at the new international high dividend yield index fund that Vanguard released earlier this year? I think it looks appealing, but it’s new so hardly has any track record. I’d be interested to hear your thoughts.”

With regard to dividend strategies in general, there’s no economic advantage to receiving dividends rather than an equal amount of price appreciation. (And in fact, there’s a disadvantage, if the fund is held in a taxable account because the dividends will be taxed immediately whereas capital gains tax isn’t incurred until holdings are sold. And capital gains tax can sometimes be avoided completely if the holdings are left to heirs.)

So a dividend strategy is only useful if there’s some reason to think that dividend stocks will outperform other stocks of similar risk.

Overweighting high-dividend stocks relative to their market weight often results in a portfolio that is heavy on value stocks — because value stocks tend to have higher than average dividends.* And both Vanguard and Morningstar do classify the new Vanguard International High Dividend Yield Index Fund as an international “large value” fund.

So how does the new fund compare to Vanguard’s existing foreign large value fund (i.e., the Vanguard International Value Fund)? The following chart (made with the Morningstar website) shows how the two have performed since the inception date of the new fund. The blue line is the new International High Dividend Yield Index Fund, and the orange line is the older International Value Fund.

international-dividend

As you can see, they have tracked each other very closely.

As far as differences, the new fund does have a slightly lower expense ratio (0.30% for Admiral shares, as opposed to 0.46% for the International Value Fund), which is certainly a good thing.

And, unlike the existing actively managed fund, there’s no possibility that the new dividend index fund will experience outperformance or underperformance due to good/bad individual stock selection. Personally, I see that as a good thing. But others may disagree if they’re more optimistic about the value of low-cost active management.

In other words, if you’re looking for an international large-cap value fund to add to your portfolio, the new Vanguard International High Dividend Yield Index Fund looks like a perfectly good choice. I would not say, however, that it is anything particularly groundbreaking compared to Vanguard’s older offerings.

*Brief tangent: I recently encountered this article by Rick Ferri, which does a great job explaining why the value premium may be directly tied to dividends.

Social Security Inflation Adjustments (COLA and Wage Indexing)

In the last two weeks I’ve received an assortment of questions about how, exactly, Social Security inflation adjustments work.

In brief, there are two types of inflation-indexing that occur with Social Security: indexing of your earnings history and indexing of retirement/disability benefits (and other benefits based on retirement/disability benefits).

Indexing Your Earnings History

When calculating your “average indexed monthly earnings” (i.e., the earnings history that is used to determine your retirement or disability benefit), all earnings that occur prior to age 60 are indexed to age-60 dollars.* This indexing is not based on price inflation but rather on wage inflation, as measured by the national average wage index.

For example, if the national average wage was twice at high in your age-60 year as in your age-40 year, your earnings from age 40 would be included at twice their actual dollar amount when calculating your earnings history.

Earnings after age 60* are not indexed. As it turns out, this usually lets them count for more than if they were indexed (because if they were indexed, they’d have to be indexed to age-60 dollars, which would be a downward indexing in most cases).

Cost of Living Adjustments (COLA)

Beginning at age 62 (or, if earlier, the year in which you die or become disabled), your primary insurance amount (i.e., the amount of your monthly retirement benefit, if you were to file for it at exactly full retirement age), begins to be indexed upward each year for price inflation, as measured by the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W).

Specifically, the calculation is done by comparing the average monthly CPI-W from the third quarter of the current year to the average monthly CPI-W from the third quarter of the last year for which there was a COLA.

There are two key points about this cost of living adjustment.

First key point: Because the COLA is an adjustment to your PIA, it also affects the benefit of anybody else who receives benefits on your work record, such as a spouse or child.

And second: Your PIA will begin to receive a cost of living adjustment at 62 regardless of whether or not you have retired and regardless of when you file for benefits. (I’ve encountered many people who thought that you had to claim benefits in order to get your COLA — making it a point in favor of claiming early — but that’s not true at all.)

*In the event of death or disability prior to age 62, rather than using age 60, the calculation uses the year that is two years prior to the year in which you die or became disabled. That is, earnings prior to that particular year will be indexed to that year, and earnings after that year will not be indexed. For example, if you become disabled at age 47, earnings prior to age 45 would be indexed to age-45 dollars. Earnings after age 45 would not be indexed.

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8 Simple Portfolios with Fidelity Funds (and iShares ETFs)

A reader writes in, asking:

“Your page of 8 simple portfolios is great guidance for people who want a simple plan they can institute. I wondered whether that page could offer a list of Fidelity options for some of those portfolios…if they are up-to-snuff enough and low-cost enough.”

The idea of the original “8 simple portfolios” article was to provide a menu of several possible portfolios, sorted by complexity (i.e., a one-fund portfolio, two-fund portfolio, and so on). At the time, I listed Vanguard funds simply because they are my go-to company for index funds.

But, to be clear, Fidelity does have a perfectly good lineup of low-cost index funds. In addition, they offer commission-free trades on a number of iShares ETFs, which can also be used to build a low-cost, diversified, simple portfolio.

Before we get into the portfolios, let me answer a few questions first:

  • As with the previous article, in order to make comparisons easy, each of the portfolios is built using the same overall stock/bond allocation (70/30). There’s no particular reason that a 70/30 split was chosen over any other allocation. Investors with differing levels of risk tolerance would want to adjust as necessary to meet their needs.
  • Each of the portfolios uses a roughly 50/50 domestic/international allocation for the stocks, because that is what I used to use when I had a DIY portfolio. Such an allocation is not going to be a good fit for everybody. Again, adjust as necessary to match your risk tolerance.
  • I’m using the ticker symbols for the “Premium” share class for the Fidelity index funds, but the “Investor” share class versions are perfectly good options if you don’t meet the minimum investment requirement for the Premium versions.
  • With regard to tilting the portfolio toward small-cap stocks and/or value stocks: I have never done this with my own portfolio, but such tilts are one of the more compelling reasons to include several (i.e., more than three or four) funds, so I am assuming that that is the goal of the more complex allocations.

One-Fund Portfolio

I would caution against accidentally buying a “Fidelity Freedom Fund” rather than a “Fidelity Freedom Index Fund.” The non-indexed versions are quite a bit more expensive and include a whole list of bizarre allocations.

Two-Fund Portfolio

  • 70% iShares MSCI All Country World Index ETF (ACWI)
  • 30% Fidelity U.S. Bond Index Fund (FSITX) or iShares Core U.S. Aggregate Bond ETF  (AGG)

Three-Fund Portfolio

  • 35% Fidelity Total Market Index Fund (FSTVX) or iShares Core S&P Total U.S. Stock Market ETF (ITOT)
  • 35% Fidelity Total International Index Fund (FTIPX) or iShares Core MSCI Total International Stock (IXUS)
  • 30% Fidelity U.S. Bond Index Fund (FSITX) or iShares Core U.S. Aggregate Bond ETF (AGG)

Four-Fund Portfolio

  • 30% Fidelity Total Market Index Fund (FSTVX) or iShares Core S&P Total U.S. Stock Market ETF (ITOT)
  • 10% Fidelity Real Estate Index Fund (FSRVX)
  • 30% Fidelity Total International Index Fund (FTIPX) or iShares Core MSCI Total International Stock (IXUS)
  • 30% Fidelity U.S. Bond Index Fund (FSITX) or iShares Core U.S. Aggregate Bond ETF (AGG)

Five-Fund Portfolio

  • 30% Fidelity Total Market Index Fund (FSTVX) or iShares Core S&P Total U.S. Stock Market ETF (ITOT)
  • 10% Fidelity Real Estate Index Fund (FSRVX)
  • 30% Fidelity Total International Index Fund (FTIPX) or iShares Core MSCI Total International Stock (IXUS)
  • 15% Fidelity U.S. Bond Index Fund (FSITX) or iShares Core U.S. Aggregate Bond ETF (AGG)
  • 15% Fidelity Inflation-Protected Bond Index Fund (FSIYX) or iShares TIP Bond ETF (TIP)

Six-Fund Portfolio

  • 20% Fidelity 500 Index Fund (FUSVX) or iShares Core S&P 500 (IVV)
  • 10% iShares S&P Small-Cap 600 Value Index (IJS)
  • 10% Fidelity Real Estate Index Fund (FSRVX)
  • 30% Fidelity Total International Index Fund (FTIPX) or iShares Core MSCI Total International Stock (IXUS)
  • 15% Fidelity U.S. Bond Index Fund (FSITX) or iShares Core U.S. Aggregate Bond ETF (AGG)
  • 15% Fidelity Inflation-Protected Bond Index Fund (FSIYX) or iShares TIP Bond ETF (TIP)

Seven-Fund Portfolio

  • 20% Fidelity 500 Index Fund (FUSVX) or iShares Core S&P 500 (IVV)
  • 10% iShares S&P Small-Cap 600 Value Index (IJS)
  • 10% Fidelity Real Estate Index Fund (FSRVX)
  • 20% Fidelity Total International Index Fund (FTIPX) or iShares Core MSCI Total International Stock (IXUS)
  • 10% iShares MSCI EAFE Small-Cap Index (SCZ)
  • 15% Fidelity U.S. Bond Index Fund (FSITX) or iShares Core U.S. Aggregate Bond ETF (AGG)
  • 15% Fidelity Inflation-Protected Bond Index Fund (FSIYX) or iShares TIP Bond ETF (TIP)

Eight-Fund Portfolio

  • 20% Fidelity 500 Index Fund (FUSVX) or iShares Core S&P 500 (IVV)
  • 10% iShares S&P Small-Cap 600 Value Index (IJS)
  • 10% Fidelity Real Estate Index Fund (FSRVX)
  • 10% Fidelity Total International Index Fund (FTIPX) or iShares Core MSCI Total International Stock (IXUS)
  • 10% iShares MSCI EAFE Small-Cap Index (SCZ)
  • 10% iShares International Select Dividend (IDV)
  • 15% Fidelity U.S. Bond Index Fund (FSITX) or iShares Core U.S. Aggregate Bond ETF (AGG)
  • 15% Fidelity Inflation-Protected Bond Index Fund (FSIYX) or iShares TIP Bond ETF (TIP)

Solo 401(k) Contribution Limit with Another Job

A reader writes in, asking:

“For the first 9 months of 2016, I have been considered a self-employed 1099 contractor at a hospital. As of October 1st, I will be a W-2 employee, but I will be doing the same work at the same hospital.

If I have sufficient earnings as a 1099 contractor for that 9-month period in 2016, will I be able to contribute a full $53,000 to my Solo 401k with that contribution being funded as ’employer’ contributions while also contributing up to $18,000 to my 401k as an employee for the period of October 1, 2016 – December 31, 2016?”

Short answer: Yes.

[Quick note: With what follows, I am assuming that the reader is familiar with the basics of solo 401(k) contribution limits. If you are not, I’d suggest reading up on them before proceeding.]

The employee salary deferral limit for 401(k) plans (i.e., $18,000 for 2016) is a per-person limit. That is, any deferrals that are made to the plan at your job as an employee will be counted against the $18,000 limit for deferrals (i.e., “employee” contributions) to the solo 401(k) — and vice versa.

The $53,000 annual limit works differently though. This limit comes from IRC 415(c). The key point when reading that Code section is to understand that these are the rules for a given plan, rather than for a given person. That is, the plan wouldn’t be a qualified retirement plan if it let a participant contribute more than $53,000, but there’s no rule saying that a given person isn’t allowed to make more than $53,000 of total contributions if they are a participant in multiple plans.

This article from IRS.gov provides a very clear example:

“Greg, 46, is employed by an employer with a 401(k) plan and he also works as an independent contractor for an unrelated business. Greg sets up a solo 401(k) plan for his independent contracting business. Greg contributes the maximum amount to his employer’s 401(k) plan for 2015, $18,000. Greg would also like to contribute the maximum amount to his solo 401(k) plan. He is not able to make further elective deferrals to his solo 401(k) plan because he has already contributed his personal maximum, $18,000. He has enough earned income from his business to contribute the overall maximum for the year, $53,000. Greg can make a nonelective contribution of $53,000 to his solo 401(k) plan. This limit is not reduced by the elective deferrals under his employer’s plan because the limit on annual additions applies to each plan separately.”

Caution: Shared Ownership

While the $53,000 limit is a per-plan limit, it’s important to understand that, in some cases, multiple retirement plans will be aggregated (i.e., considered to be one plan). IRC 415(g) and 415(h) provide the relevant rules.

Specifically, multiple businesses will be aggregated as part of a “brother-sister controlled group” if five or fewer individuals (including people, estates, and trusts) own more than 50% of the stock of each business (measured in terms of voting power or value). Alternatively, two businesses will be aggregated as part of a “parent-subsidiary controlled group” if one business owns more than 50% of the other business (again measured in terms of voting power or value).

For example, if you are the sole owner of two single-member LLCs, those two LLCs will be aggregated for these purposes (and you will not be able to exceed the $53,000 total contribution limit), even if the two LLCs operate in completely different industries.

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