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Simple Portfolio Rebalancing Spreadsheet Template (Google Drive) — My Money Blog

Simple Portfolio Rebalancing Spreadsheet Template (Google Drive)

My Money Blog has partnered with CardRatings and Credit-Land for selected credit cards and may receive a commission. All opinions expressed are the author’s alone, and has not been provided nor approved by any of the companies mentioned.

gsheetsUpdated. Automated portfolio management services likeWealthfront and Betterment will help you manage a diversified portfolio of low-cost index funds for a fee. While I understand their appeal for those that wish to outsource that task, I choose to maintain my own diversified portfolio of low-cost index funds. I enjoy having full control of all investment decisions, and I like saving the management fee (and adding that money to my snowball).

An important part of this DIY portfolio management is staying close to your target asset allocation. I use a very simple Google Spreadsheet to track my portfolio. Here is thedirect link and it is also embedded below. Yellow cells are those meant to be edited.

 

Source: Simple Portfolio Rebalancing Spreadsheet Template (Google Drive) — My Money Blog

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Guide to Asset Classes & ETFs

Introduction

A foundational belief that underlies Schwab Intelligent Portfolios® is that investors should be well diversified, both within and across asset classes. Within the program, any portfolio may contain up to 20 expanded asset classes, along with an FDIC-insured cash allocation. That begs the question, what is an asset class?

It’s not an entirely precise concept. Generally speaking, an asset class is a group of investments such as stocks and bonds that can be further broken down by characteristics such as market capitalization and level of risk. Like so many definitions, though, the technical terms can only do so much. Examples bring the term to life far more powerfully.

This document is a guide to the asset classes that are present in at least one of the portfolios that comprise Schwab Intelligent Portfolios. In addition to describing the investments that are included in each asset class, we’ve highlighted the role each plays in a portfolio and when they tend to perform well and poorly.

This white paper also includes a list of the ETFs selected for each asset class within Schwab Intelligent Portfolios. ETFs are selected based on stringent criteria to ensure that all ETFs within the program—whether Schwab ETFs™ or third-party ETFs—deliver accurate asset class representation with low costs. These selection criteria include characteristics such as assets under management (AUM), ETF liquidity, how closely the ETF tracks its underlying index, operating expense ratio (OER), and other criteria.1

These selection criteria help pare down more than 2,000 ETFs to the 53 included in the program that could potentially be part of your Schwab Intelligent Portfolios account. Most asset classes include two ETFs, a primary ETF and a secondary ETF. To enable tax-loss harvesting2 within asset classes, the primary and secondary ETFs selected for the program track different underlying indexes.3 Along with the name and ticker symbol for each of the 53 ETFs included in the program, this document provides details on why each ETF was selected for inclusion and why other ETFs were not selected.

CSIA periodically reviews and updates the selected ETFs in our portfolios. All ETF data shown in this paper is as of April 30, 2020, to coincide with the last review process.

Guide to Expanded Asset Classes

Stocks

  • US Large Company Stocks
  • US Large Company Stocks–Fundamental
  • US Small Company Stocks
  • US Small Company Stocks–Fundamental
  • International Developed Large Company Stocks
  • International Developed Large Company Stocks–Fundamental
  • International Developed Small Company Stocks
  • International Developed Small Company Stocks–Fundamental
  • International Emerging Market Stocks
  • International Emerging Market Stocks–Fundamental
  • US Exchange-Traded REITs
  • International Exchange-Traded REITs
  • US High Dividend Stocks
  • International High Dividend Stocks
  • Master Limited Partnerships

Fixed Income

  • US Treasuries
  • US Investment Grade Corporate Bonds
  • US Securitized Bonds
  • US  Inflation Protected Bonds
  • US Corporate High Yield Bonds
  • International Developed Country Bonds
  • International Emerging Market Bonds
  • Preferred Securities
  • Bank Loans
  • Investment Grade Municipal Bonds
  • Investment Grade California Municipal Bonds

Commodities

  • Gold and Other Precious Metals

Cash

  • FDIC-insured cash

ETF List (As of 4/30/2020)

Stocks
Category Primary ETF Secondary ETF
US Large Company SCHX–Schwab U.S. Large-Cap VOO–Vanguard S&P 500
US Large Company–Fundamental FNDX–Schwab Fundamental U.S. Large Company PRF–Invesco FTSE RAFI US 1000
US Small Company SCHA–Schwab U.S. Small-Cap VB–Vanguard Small-Cap
US Small Company–Fundamental FNDA–Schwab Fundamental U.S. Small Company PRFZ–Invesco FTSE RAFI US 1500 Small-Mid
International Developed Large Company SCHF–Schwab International Equity VEA–Vanguard FTSE Developed Markets
International Developed Large Company -Fundamental FNDF–Schwab Fundamental International Large Company PXF–Invesco FTSE RAFI Developed Markets ex-U.S.
International Developed–Small Company SCHC–Schwab International Small-Cap Equity VSS–Vanguard FTSE All-World ex-U.S. Small Cap
International Developed Small Company–Fundamental FNDC–Schwab Fundamental International Small Company PDN–Invesco FTSE RAFI Developed Markets ex-U.S. Small-Mid
International Emerging Markets SCHE–Schwab Emerging Markets Equity IEMG–iShares Core MSCI Emerging Markets
International Emerging Markets–Fundamental FNDE–Schwab Fundamental Emerging Markets Large Company PXH–Invesco FTSE RAFI Emerging Markets
US Exchange-Traded REITS SCHH–Schwab U.S. REIT USRT- iShares Core U.S. REIT
International Exchange-Traded REITS HAUZ–Xtrackers International Real Estate VNQI–Vanguard Global ex-U.S. Real Estate
US High Dividend SCHD–Schwab U.S. Dividend Equity VYM–Vanguard High Dividend Yield
International High Dividend HDEF–Xtrackers MSCI EAFE High Dividend Yield Equity ETF VYMI–Vanguard International High Dividend Yield
Master Limited Partnerships MLPA–Global X MLP AMLP–Alerian MLP
Fixed Income
Category Primary ETF Secondary ETF
US Treasuries SCHR–Schwab Intermediate-Term U.S. Treasury IEI–iShares 3-7 Year Treasury Bond
US Investment Grade Corporate Bonds VCIT–Vanguard Intermediate-Term Corporate Bond SPIB–SPDR® Portfolio Intermediate Term Corporate Bond
US Securitized Bonds VMBS–Vanguard Mortgage-Backed Securities MBB–iShares MBS
US Inflation Protected Bonds SCHP–Schwab U.S. TIPS SPIP–SPDR Portfolio TIPS
US Corporate High Yield Bonds HYLB–Xtrackers USD High Yield Corporate Bond USHY–iShares Broad USD High Yield Corp Bond
International Developed Country Bonds BNDX–Vanguard Total International Bond IAGG–iShares Core International Aggregate Bond
International Emerging Markets Bonds EBND–SPDR® Bloomberg Barclays Emerging Markets Local Bond EMLC– VanEck Vectors JP Morgan EM Local Currency Bond
Preferred Securities PFFD–Global X US Preferred PSK–SPDR Wells Fargo Preferred Stock
Bank Loans BKLN–Invesco Senior Loan N/A
Investment Grade Municipal Bonds VTEB–Vanguard Tax-Exempt Bond TFI–SPDR® Nuveen Bloomberg Barclays Muni Bond
Investment Grade California Municipal Bonds CMF–iShares California Muni Bond PWZ–Invesco California AMT-Free Muni Bond
Commodities
Category Primary ETF Secondary ETF
Gold and Other Precious Metals IAU–iShares Gold Trust GLTR– Aberdeen Standard Physical Precious Metals Basket Shares

Stocks

US Large Company Stocks

  • What is it?
    Large company stocks—or “large caps”—are investments in the equity of larger US companies, generally those with more than $10 billion in market capitalization, such as Exxon Mobil Corporation or Microsoft Corporation. Large company stocks are perceived to carry less risk than smaller company stocks since they generally have more assets and a longer track record of performance, but they may not provide as much growth potential.
  • What role does it play in a portfolio?
    Relative to some other asset classes, such as bonds, large cap stocks have higher expected long-term returns to compensate for the higher risk associated with them.
  • When does it perform well?
    There are many factors that influence the performance of US large company stocks. In practice, many of these factors are exerting their influence on stock prices simultaneously and on each other. The US Large Company Stocks tend to do well when inflation is low or moderate. These stocks also perform well when the US economy is expected to grow and when interest rates are low. Valuation matters as well. When prices are low relative to, for example, earnings, subsequent price performance is more likely to be strong.
  • When does it perform poorly?
    These stocks perform poorly during economic slowdowns or expectations of such slowdowns and when interest rates are high. Unexpected inflation may also hurt these stocks. When prices are high relative to earnings, price performance can suffer.
  • ETF Selection
    ETF Selection
    Name Ticker Operating Expense Ratio
    Primary ETF Schwab U.S. Large-Cap SCHX 0.03%
    Secondary ETF Vanguard S&P 500 VOO 0.03%

    Source: Morningstar Direct, as of 4/30/2020.

    Why these ETFs were selected: SCHX and VOO had two of the lowest operating expense ratios among more than 60 U.S. large company stock ETFs at the time of ETF selection. Both funds have historically produced returns that consistently tracked their underlying indices closely. In addition, SCHX and VOO each had sizable assets under management (well above $10 billion), and have traded with tight average bid-ask spreads historically. While both funds reach slightly into the mid-cap space to provide additional diversification and potential for growth, their portfolios have historically been dominated by very large U.S. companies.

    Why other ETFs were not selected: SPDR® S&P 500 ETF (SPY) is the largest ETF in the Morningstar U.S. Fund Large Blend category (and the largest ETF period), and it has a history of trading with narrow bid-ask spreads. However, it has a higher expense ratio than our primary and alternate ETFs. Expense ratios are the most reliable component of total cost, and over a long-term holding period differences in bid-ask spread are less material than differences in operating expense ratio. CSIA also considers the potential impact to clients such as trading or other costs when selecting an ETF which would replace an existing ETF in the portfolios.

US Large Company Stocks—Fundamental

  • What is it?
    U.S. large company stocks—fundamental are investments of larger U.S. companies that are included in fundamental indexes, which screen and weight companies based on fundamental factors such as sales, cash flow and dividends. Most traditional stock indexes are constructed based on market-cap (e.g., S&P 500®, Russell 2000®, etc.), where companies with the largest market capitalizations have the largest weights. Including allocations to fundamentally weighted indexes adds diversification within a portfolio and may improve risk-adjusted returns over time. Due to their differences in construction, fundamentally weighted indexes tend to behave differently than market cap-weighted indexes in different market environments while retaining benefits of traditional indexing such as transparency and relatively low cost implementation. For more information about Fundamental Indexing, please read “Fundamentally weighted ETFs add value while keeping investor costs low.”
  • What role does it play in a portfolio?
    Investments in fundamentally weighted ETFs and traditional market-cap weighted ETFs can be used as a complement to each other because they differ in their performance under various market environments. The end result is a portfolio that we believe will result in better risk-adjusted results over time.
  • When does it perform well?
    Based on research conducted by Research Affiliates, FTSE Russell, and Schwab Center for Financial Research among others, fundamental index strategies have outperformed market-cap indexes over longer time periods. This is partly attributable to the fact that the fundamental strategies break the link of assigning a weighting with the price of the stock. A market-cap index provides the largest weighting to the largest companies regardless of valuation. As a result, market-cap indexes can be described as “overweighting over priced stocks and underweighting undervalued stocks.”4 Since fundamental index strategies tend to overweight companies that appear cheap based on various financial metrics, they tend to outperform in environments that reward such “cheap” aka value stocks. As for their absolute level of performance, fundamental strategies are affected in much the same way and by the same factors as US large company stocks.
  • When does it perform poorly?
    Fundamental index strategies may lag market-cap indexes in “boom” or “momentum” periods or when the biggest companies (as measured by market capitalization) dramatically outperform the smaller companies in an index.
  • ETF Selection
    ETF Selection
    Name Ticker Operating Expense Ratio
    Primary ETF Schwab Fundamental U.S. Large Company FNDX 0.25%
    Secondary ETF Invesco FTSE RAFI US 1000 PRF 0.39%

    Source: Morningstar Direct, as of 4/30/2020.

    Why these ETFs were selected: Based on Morningstar classifications, two ETF providers offered ETFs in this category at the time of ETF selection. While there are many indexing approaches that incorporate various fundamental factors, classifications for fundamental strategies within Schwab Intelligent Portfolios are based on Morningstar’s classification for index selection and index weighting (among other data points). From among the eligible funds in this asset class, FNDX had the lowest operating expense ratio at the time of ETF selection while meeting all other criteria. Both FNDX and PRF had sizable assets under management and have historically traded with relatively narrow bid-ask spreads.

    Why other ETFs were not selected: The category consists of just two ETFs.

US Small Company Stocks

  • What is it?
    U.S. small company stocks—or “small caps”—are investments in the equity of smaller U.S. companies, generally those that represent the bottom 10% of the market by cumulative market capitalization. Small company stocks may provide greater potential for growth than large company stocks. However, they are riskier because their size makes them more vulnerable to economic shocks, inexperienced management, competition and financial instability.
  • What role does it play in a portfolio?
    The US small company stocks offer higher growth potential than many other asset classes because of the potential for such companies to grow rapidly. Small cap stocks have higher expected long-term returns relative to other asset classes to compensate for the higher risk associated with them.
  • When does it perform well?
    U.S. small company stocks generally perform well when the economy is expanding or investors expect such expansion to occur. Small company stocks tend to be more closely tied to the strength of the U.S. economy than large company stocks because they typically generate most of their revenue within the U.S. while large multinational companies often generate a substantial portion of revenue in multiple geographies around the world. Valuation matters as well. When prices are low relative to, for example, earnings, subsequent price performance is more likely to be strong.
  • When does it perform poorly?
    During extreme equity market or economic stress, these stocks tend to perform poorly. When prices are high relative to earnings, price performance can suffer.
  • ETF Selection
    ETF Selection
    Name Ticker Operating Expense Ratio
    Primary ETF Schwab U.S. Small Cap SCHA 0.04%
    Secondary ETF Vanguard Small-Cap VB 0.05%

    Source: Morningstar Direct, as of 4/30/2020.

    Why these ETFs were selected: SCHA and VB had operating expense ratios which were among the lowest for U.S. small company stock ETFs at the time of ETF selection. Both of these ETFs have historically traded with tight bid-ask spreads. Diversification is particularly important in the small cap market segment, and SCHA and VB each hold more than 1,200 small cap stocks. Many of the ETFs in this category have fewer than 600 holdings, while a handful have fewer than 300 holdings.

    Why other ETFs were not selected: Among other U.S. small company stock ETFs, iShares Russell 2000 (IWM) and iShares Core S&P Small-Cap (IJR) are both large, well-diversified ETFs that trade with tight bid-ask spreads. However, both had significantly higher expense ratios at the time of ETF selection.

US Small Company Stocks—Fundamental

  • What is it?
    U.S. small company stocks—fundamental are investments in the equity of smaller U.S. companies that are included in fundamental indexes, which screen and weight companies based on fundamental factors such as sales, cash flow and dividends. Most traditional stock indexes are constructed based on market-cap (e.g., S&P 500®, Russell 2000®, etc.), where companies with the largest market capitalizations have the largest weights. Including allocations to fundamentally weighted indexes adds diversification within a portfolio and may improve risk-adjusted returns over time. Due to their differences in construction, fundamentally weighted indexes tend to behave differently than market cap-weighted indexes in different market environments while retaining benefits of traditional indexing such as transparency and relatively low cost implementation. For more information about Fundamental Indexing, please see the article “Fundamentally weighted ETFs add value while keeping investor costs low“.
  • What roles does it play in a portfolio?
    Investments in fundamentally weighted ETFs and traditional market-cap weighted ETFs can be used as a complement to each other because they differ in their performance under various market environments. The end result is a portfolio that we believe will result in better risk-adjusted results over time.
  • When does it perform well?
    Based on research conducted by Research Affiliates, FTSE Russell, and Schwab Center for Financial Research among others, fundamental index strategies have outperformed market-cap indexes over longer time periods. This is partly attributable to the fact that the fundamental strategies break the link of assigning a weighting with the price of the stock. A market-cap index provides the largest weighting to the largest companies regardless of valuation. As a result, market-cap indexes can be described as “overweighting over priced stocks and underweighting undervalued stocks.”5 Since fundamental index strategies tend to overweight companies that appear cheap based on various financial metrics, they tend to outperform in environments that reward such “cheap” aka value stocks.  As for their absolute level of performance, fundamental strategies are affected in much the same way and by the same factors as US small company stocks.
  • When does it perform poorly?
    Fundamental strategies may lag market-cap indexes in “boom” or “momentum” periods or when the biggest companies (as measured by market capitalization) dramatically outperform the smaller companies in an index.
  • ETF Selection
    ETF Selection
    Name Ticker Operating Expense Ratio
    Primary ETF Schwab Fundamental U.S. Small Company FNDA 0.25%
    Secondary ETF Invesco FTSE RAFI US 1500 PRFZ 0.39%

    Source: Morningstar Direct, as of 4/30/2020.

    Why these ETFs were selected: Based on Morningstar classifications, two ETF providers offered ETFs in this category at the time of ETF selection. While there are many indexing approaches that incorporate various fundamental factors, classifications for fundamental strategies within Schwab Intelligent Portfolios are based on Morningstar’s classifications for index selection and index weighting (among other data points). At the time of ETF selection, there were only two ETFs classified within this category. Both FNDA and PRFZ had over $1 billion in assets under management and have historically traded with relatively narrow bid-ask spreads. FNDA was selected as the primary ETF because it had the lowest expense ratio at the time of ETF selection. PRFZ, which is slightly more expensive, was selected as the alternate.

    Why other ETFs were not selected: The category consists of just two ETFs.

International Developed Large Company Stocks

 

  • What is it?
    International developed large company stocks are investments in the equity of larger foreign companies that have high market capitalizations and are domiciled in countries with mature economies. The stock markets in these developed countries benefit from strong investor protections, corporate governance and legal infrastructure. Investing in these stocks involves additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets.
  • What role does it play in a portfolio?
    While U.S. companies can have vast international operations and exposure, investing solely in U.S. stocks means excluding nearly three-fourths of the global economy and over half of the world’s stock market value. International developed large company stocks provide some of the same benefits as U.S. large-company stocks – growth potential and more stable financial results than smaller foreign companies – but provide diversification benefits due to their exposure to non-U.S. markets. In addition, investing in companies located overseas offers the potential to benefit from currency diversification—foreign company returns are generally denominated in foreign currencies, so they provide some protection against a potential fall in the value of the U.S. dollar relative to those currencies.
  • When does it perform well?
    This asset class tends to perform well when international developed countries are growing more rapidly than the U.S. and when their currencies are appreciating against the U.S. dollar. Valuation matters as well. When prices are low relative to, for example, earnings, subsequent price performance is more likely to be strong.
  • When does it perform poorly?
    When the U.S. dollar is gaining against these currencies, this asset class tends to perform poorly relative to U.S. stocks. The relative performance can also be poor when non-U.S. economies are weakening or expected to weaken. When prices are high relative to earnings, price performance can suffer.
  • ETF Selection
    ETF Selection
    Name Ticker Operating Expense Ratio
    Primary ETF Schwab International Equity SCHF 0.06%
    Secondary ETF Vanguard FTSE Developed Markets VEA 0.05%

    Source: Morningstar Direct, as of 4/30/2020.

    Why these ETFs were selected: SCHF and VEA provide diversified, low-cost exposure to developed market equities and had large amounts of assets, each with more than $10 billion in AUM at the time of ETF selection. These two ETFs had some of the lowest expense ratios in their category, and have historically traded with tight average bid-ask spreads.

    Why other ETFs were not selected: The largest fund in this category by assets is iShares MSCI EAFE (EFA), which also trades with a narrow bid-ask spread. However, EFA’s expense ratio was significantly higher at the time of ETF selection. Among other potential ETFs in this category, iShares Core MSCI EAFE (IEFA) also had a higher expense ratio. CSIA also considers the potential impact to clients such as trading or other costs when selecting an ETF which would replace an existing ETF in the portfolios.

International Developed Large Company Stocks—Fundamental

  • What is it?
    International developed large company stocks – fundamental are investments in the equities of larger foreign companies that are included in fundamental indexes, which screen and weight companies based on fundamental factors such as sales, cash flow and dividends. Most traditional stock indexes are constructed based on market-cap (e.g., S&P 500®, Russell 2000®, etc.), where companies with the largest market capitalizations have the largest weights. Including allocations to fundamentally weighted indexes adds diversification within a portfolio and may improve risk-adjusted returns over time. Due to their differences in construction, fundamentally weighted indexes tend to behave differently than market cap-weighted indexes in different market environments while retaining benefits of traditional indexing such as transparency and relatively low cost implementation. For more information about Fundamental Indexing, please read “Fundamentally weighted ETFs add value while keeping investor costs low.”
  • What role does it play in a portfolio?
    Investments in fundamentally weighted ETFs and traditional market-cap weighted ETFs can be used as complements in an investment portfolio because they tend to perform differently in various market environments. Including both market cap-weighted and fundamentally weighted ETFs in a portfolio can enhance diversification and potentially improve risk-adjusted results over time.
  • When does it perform well?
    Based on research conducted by Research Affiliates, FTSE Russell, Schwab Center for Financial Research and others, fundamental index strategies have outperformed market-cap indexes over longer time periods. This is partly attributable to the fact that fundamental strategies break the link of assigning a weighting with the price of the stock. A market-cap index provides the largest weighting to the largest companies by market cap regardless of valuation. As a result, market-cap indexes can be described as “overweighting over priced stocks and underweighting undervalued stocks.”6 Since fundamental index strategies tend to overweight companies that appear cheap based on various financial metrics, they tend to outperform in environments that reward such “cheap” aka value stocks. As for their absolute level of performance, fundamental strategies are affected in much the same way and by the same factors as other international developed large company stocks.
  • When does it perform poorly?
    Fundamental index strategies may lag market-cap indexes in “boom” or “momentum” periods or when the biggest companies (as measured by market capitalization) dramatically outperform the smaller companies in an index.
  • ETF Selection
    ETF Selection
    Name Ticker Operating Expense Ratio
    Primary ETF Schwab Fundamental International Large Company FNDF 0.25%
    Secondary ETF Invesco FTSE RAFI Developed Markets ex-U.S. PXF 0.45%

    Source: Morningstar Direct, as of 4/30/2020.

    Why these ETFs were selected: Based on Morningstar classifications, two ETF providers offered ETFs in this category at the time of ETF selection. While there are many indexing approaches that incorporate various fundamental factors, classifications for fundamental strategies within Schwab Intelligent Portfolios are based on Morningstar’s classifications for index selection and index weighting (among other data points). Among the two ETFs in this category, FNDF was selected as the primary ETF because it had the lowest expense ratio at the time of ETF selection. PXF, which was slightly more expensive in terms of OER, was selected as the secondary ETF. Both FNDF and PXF had sizable assets under management and have historically traded with relatively narrow bid-ask spreads.

    Why other ETFs were not selected: The category consists of just two ETFs.

International Developed Small Company Stocks

  • What is it?
    International developed small company stocks are investments in the equity of smaller foreign companies that are domiciled in countries with mature economies and stock markets that benefit from strong investor protections, corporate governance and legal infrastructure. Investing in international developed small company stocks involves additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets.
  • What role does it play in a portfolio?
    Like U.S. small company stocks, these investments offer greater potential for growth than their large-cap counterparts. In addition, they provide diversification relative to U.S. markets because the revenues of these companies tend to be tightly tied to their home countries. By contrast, large multinational companies typically generate revenues in multiple geographies around the world.
  • When does it perform well?
    International developed small company stocks typically perform well during the earlier stages of a global economic recovery. A strong foreign currency relative to the dollar also enhances the returns of international developed small company stocks. Valuation matters as well. When prices are low relative to, for example, earnings, subsequent price performance is more likely to be strong.
  • When does it perform poorly?
    A struggling global economy adversely impacts the performance of these stocks. When prices are high relative to earnings, price performance can suffer.
  • ETF Selection

    ETF Selection
    Name Ticker Operating Expense Ratio
    Primary ETF Schwab International Small-Cap Equity SCHC 0.11%
    Secondary ETF Vanguard FTSE All-World ex-US Small Cap VSS 0.11%

    Source: Morningstar Direct, as of 4/30/2020.

    Why these ETFs were selected: Finding low-cost exposure to international small company stocks can be challenging. Among the ten funds in this category, expense ratios ranged from 0.11% to 0.80%. Among the eligible ETFs in the category, SCHC and VSS had the lowest expense ratios at the time of ETF selection. Each of our selected ETFs also had more than $1 billion in AUM at the time of ETF selection and has historically traded with relatively narrow bid-ask spreads.

    Why other ETFs were not selected: iShares MSCI EAFE Small-Cap (SCZ) is the largest ETF in this category but had a significantly higher expense ratio at the time of ETF selection. SPDR® S&P International Small Cap ETF (GWX) also has a higher expense ratio.

International Developed Small Company Stocks—Fundamental

  • What is it?
    International developed small company stocks – fundamental are investments in the equities of smaller foreign companies that are included in fundamental indexes, which screen and weight companies based on fundamental factors such as sales, cash flow and dividends. Most traditional stock indexes are constructed based on market-cap (e.g., S&P 500®, Russell 2000®, etc.), where companies with the largest market capitalizations have the largest weights. Including allocations to fundamentally weighted indexes adds diversification within a portfolio and may improve risk-adjusted returns over time. Due to their differences in construction, fundamentally weighted indexes tend to behave differently than market cap-weighted indexes in different market environments while retaining benefits of traditional indexing such as transparency and relatively low cost implementation. For more information about Fundamental Indexing, please read “Fundamentally weighted ETFs add value while keeping investor costs low.”
  • What role does it play in a portfolio?
    Investments in fundamentally weighted ETFs and traditional market-cap weighted ETFs can be used as complements in an investment portfolio because they tend to perform differently in various market environments. Including both market cap-weighted and fundamentally weighted ETFs in a portfolio can enhance diversification and potentially improve risk-adjusted results over time.
  • When does it perform well?
    Based on research conducted by Research Affiliates, FTSE Russell, Schwab Center for Financial Research and others, fundamental index strategies have outperformed market-cap indexes over longer time periods. This is partly attributable to the fact that fundamental strategies break the link of assigning a weighting with the price of the stock. A market-cap index provides the largest weighting to the largest companies by market cap regardless of valuation. As a result, market-cap indexes can be described as “overweighting over priced stocks and underweighting undervalued stocks.”7 Since fundamental index strategies tend to overweight companies that appear cheap based on various financial metrics, they tend to outperform in environments that reward such “cheap” aka value stocks. As for their absolute level of performance, fundamental strategies are affected in much the same way and by the same factors as other international developed small company stocks.
  • When does it perform poorly?
    Fundamental index strategies may lag market-cap indexes in “boom” or “momentum” periods, or when the biggest companies (as measured by market capitalization) dramatically outperform the smaller companies in an index.
  • ETF Selection
    ETF Selection
    Name Ticker Operating Expense Ratio
    Primary ETF Schwab Fundamental International Small Company FNDC 0.39%
    Secondary ETF Invesco FTSE RAFI Developed Markets ex-U.S. Small-Mid PDN 0.49%

    Source: Morningstar Direct, as of 4/30/2020.

    Why these ETFs were selected: Based on Morningstar classifications, two ETF providers offered ETFs in this category at the time of ETF selection. While there are many indexing approaches that incorporate various fundamental factors, classifications for fundamental strategies within Schwab Intelligent Portfolios are based on Morningstar’s classifications for index selection and index weighting (among other data points). Among the two ETFs in the category, FNDC was selected as the primary ETF because it had the lowest expense ratio at the time of ETF selection and has historically exhibited slightly higher liquidity.

    Why other ETFs were not selected: The category consists of just two ETFs.

International Emerging Market Stocks

  • What is it?
    Emerging market stocks are equity investments in foreign companies domiciled in countries with developing economies that have been experiencing rapid growth and industrialization. Emerging markets differ from their developed market counterparts in four main ways: (1) They have lower household incomes; (2) They are undergoing structural changes, such as modernization of infrastructure or moving from a dependence on agriculture to manufacturing; (3) Their economies are undergoing development and reform programs; (4) Their markets are less mature. Emerging markets are riskier than developed markets due to greater potential for political instability, currency fluctuations, an uncertain regulatory environment, volatility and higher investment costs.
  • What role does it play in a portfolio?
    Emerging markets offer a unique combination of benefits: (1) Higher growth potential than developed markets. For investors, this is important because corporate revenues have the potential to grow faster when economic growth is higher. (2) Diversification. By investing in emerging markets, diversification increases as emerging markets can perform differently than developed markets. (3) The potential to discover up-and-coming companies.
  • When does it perform well?
    Emerging market stocks generally perform well during periods of faster growth when commodities are trading at relatively high levels, local export markets are thriving due to a growing economy, and local governments implement policies more conducive to private sector growth. Valuation matters as well. When prices are low relative to, for example, earnings, subsequent price performance is more likely to be strong.
  • When does it perform poorly?
    Emerging market stocks typically struggle when the U.S. is in a recession or experiencing a slow-growth environment. Also, due to their relatively high dependence on commodity sales, they typically don’t perform well when commodities are experiencing declining prices. Periods of high geopolitical risk are also harmful for emerging market stocks. When stock prices are high relative to earnings, price performance can suffer.
  • ETF Selection

    ETF Selection
    Name Ticker Operating Expense Ratio
    Primary ETF Schwab Emerging Markets Equity SCHE 0.11%
    Secondary ETF iShares Core MSCI Emerging Markets IEMG 0.13%

    Source: Morningstar Direct, as of 4/30/2020.

    Why these ETFs were selected: Nimble analysis is required to avoid potential pitfalls among emerging market equity ETFs. SCHE and IEMG both provide exposure to a diversified group of countries, unlike some funds which limit exposure to a single region or have a high concentration in one particular country. Furthermore, these are large ETFs with more than $5 billion in AUM each at the time of ETF selection. Each of these ETFs had low operating expense ratios at the time of ETF selection and have historically traded with relatively narrow bid-ask spreads (less than 0.05% in a category where spreads can be as high as 1%).

    Why other ETFs were not selected: iShares MSCI Emerging Markets (EEM) is the third largest ETF in this category but had a significantly higher expense ratio at the time of ETF selection. CSIA also considers the potential impact to clients such as trading or other costs when selecting an ETF which would replace an existing ETF in the portfolios.

International Emerging Market Stocks—Fundamental

  • What is it?
    International emerging market stocks—fundamental are investments in the equity of foreign companies that are based in countries experiencing rapid growth and industrialization, and are included in fundamental indexes, which screen and weight companies based on fundamental factors such as sales, cash flow and dividends. Most traditional stock indexes are constructed based on market-cap (e.g., S&P 500®, Russell 2000®, etc.), where companies with the largest market capitalizations have the largest weights. Including allocations to fundamentally weighted indexes adds diversification within a portfolio and may improve risk-adjusted returns over time. Due to their differences in construction, fundamentally weighted indexes tend to behave differently than market cap-weighted indexes in different market environments while retaining benefits of traditional indexing such as transparency and relatively low cost implementation. For more information about Fundamental Indexing, please read “Fundamentally weighted ETFs add value while keeping investor costs low.”
  • What role does it play in a portfolio?
    Investments in fundamentally weighted ETFs and traditional market-cap weighted ETFs can be used as complements in an investment portfolio because they tend to perform differently in various market environments. Including both market cap-weighted and fundamentally weighted ETFs in a portfolio can enhance diversification and potentially improve risk-adjusted results over time.
  • When does it perform well?
    Based on research conducted by Research Affiliates, FTSE Russell, Schwab Center for Financial Research and others, fundamental index strategies have outperformed market-cap indexes over longer time periods. This is partly attributable to the fact that fundamental strategies break the link of assigning a weighting with the price of the stock. A market-cap index provides the largest weighting to the largest companies by market cap regardless of valuation. As a result, market-cap indexes can be described as “overweighting over priced stocks and underweighting undervalued stocks.”8 Since fundamental index strategies tend to overweight companies that appear cheap based on various financial metrics, they tend to outperform in environments that reward such “cheap” aka value stocks. As for their absolute level of performance, fundamental strategies are affected in much the same way and by the same factors as other emerging market stocks.
  • When does it perform poorly?
    Fundamental index strategies may lag market-cap indexes in “boom” or “momentum” periods or when the biggest companies (as measured by market capitalization) dramatically outperform the smaller companies in an index.
  • ETF Selection
    ETF Selection
    Name Ticker Operating Expense Ratio
    Primary ETF Schwab Fundamental Emerging Markets Large Company FNDE 0.39%
    Secondary ETF Invesco FTSE RAFI Emerging Markets PXH 0.50%

    Source: Morningstar Direct, as of 4/30/2020.

    Why these ETFs were selected: Based on Morningstar classifications, two ETF providers offered ETFs in this category at the time of ETF selection. While there are many indexing approaches that incorporate various fundamental factors, classifications for fundamental strategies within Schwab Intelligent Portfolios are based on Morningstar’s classifications for index selection and index weighting (among other data points). Among the two ETFs in this category, FNDE was selected as the primary ETF because it had the lowest expense ratio at the time of ETF selection. PXH, which had a slightly higher expense ratio, was selected as the secondary ETF. Both ETFs had more than $1 billion in assets under management at the time of ETF selection and have traded with reasonable average bid-ask spreads historically.

    Why other ETFs were not selected: The category consists of just two ETFs.

US Exchange-Traded REITs

  • What is it?
    US exchange-traded REITs (Real Estate Investment Trusts) are investments in real estate investment trusts focused on real estate and/or mortgages or mortgage securities traded on US exchanges. REITs must pay 90% of their taxable income to shareholders every year.
  • What role does it play in a portfolio?
    Investors have long flocked to REITs (and real estate in general) because of their reputation as a hedge against inflation, as a way to increase diversification, and to generate income.
  • When does it perform well?
    Since dividends from REITs generally increase with inflation, REITs tend to do better than most other asset class in moderate or high inflation environments.
  • When does it perform poorly?
    REITs do poorly during recessions as occupancy rates and valuations may both fall in such environments. REITs also tend to do poorly during periods of rising interest rates when that rise isn’t accompanied by higher inflation.
  • ETF Selection
    ETF Selection
    Name Ticker Operating Expense Ratio
    Primary ETF Schwab U.S. REIT SCHH 0.07%
    Secondary ETF iShares Core U.S. REIT USRT 0.08%

    Source: Morningstar Direct, as of 4/30/2020.

    Why these ETFs were selected: SCHH and USRT track market-cap weighted indexes of U.S. REITs, which are companies that own (and frequently manage) commercial and residential property. SCHH was selected as the primary ETF because it had the lowest expense ratio at the time of ETF selection. USRT also had a low expense ratio and was selected as the secondary ETF. Each of these ETFs are managed by firms with significant assets under management at the time of ETF selection.

    Why other ETFs were not selected: Among other ETFs in this category, iShares Cohen & Steers REIT (ICF) and iShares US Real Estate (IYR) had significantly higher expense ratios at the time of ETF selection.

International Exchange-Traded REITs

  • What is it?
    International exchange-traded REITs are investments in real estate investment trusts focused on real estate and/or mortgage securities traded in foreign countries. Like most securities, REITs are exposed to potential downturns in specific sectors/regions of the real-estate markets and the broader economy and also contain additional risks due to potential leverage.
  • What role does it play in a portfolio?
    International real estate is appealing for a number of reasons: It has the potential to deliver strong performance, attractive yields and diversification relative to traditional investments. In addition, investing in companies located overseas offers the potential to benefit from currency diversification. Foreign company returns are denominated in foreign currencies, so they provide some protection against a potential fall in the value of the U.S. dollar relative to those currencies.
  • When does it perform well?
    As is the case with many other securities with exposure to real estate markets, international REITs typically perform well during declining interest rate environments and when banks are expanding their lending portfolios. They also tend to hold up well against inflationary pressures.
  • When does it perform poorly?
    As is the case with most asset classes, recessions generally don’t bode well for international exchange-traded REITs. Periods of sharply rising interest rates can also be difficult for this type of investment.
  • ETF Selection
    ETF Selection
    Name Ticker Operating Expense Ratio
    Primary ETF Xtrackers International Real Estate HAUZ 0.10%
    Secondary ETF Vanguard Global ex-U.S. Real Estate VNQI 0.12%

    Source: Morningstar Direct, as of 4/30/2020.

    Why these ETFs were selected: Since U.S. REITs are a different asset class within Schwab Intelligent Portfolios; the ETFs selected here should target REITs from outside the U.S. HAUZ and VNQI provide well-rounded exposure to international REITs, and they have the lowest OERs in this category.

    Why other ETFs were not selected: SPDR® Dow Jones International Real Estate ETF (RWX) is the second largest fund in this category (following VNQI). The ETF has historically traded with a narrow bid-ask spread, but it was not selected because it had a significantly higher expense ratio at the time of ETF selection. Among other ETFs in this category, iShares International Developed Property (WPS) and SPDR® Dow Jones Global Real Estate ETF (RWO) also had higher expense ratios.

US High Dividend Stocks

  • What is it?
    US high dividend stocks are investments in the equity of US companies that tend to distribute higher-than-average dividends to shareholders.
  • What role does it play in a portfolio?
    These stocks typically are well-suited for investors seeking both growth and income from their investments because they deliver more predictable annual income than the average stock, may reduce volatility and could appreciate over time. Dividend-paying companies are generally perceived to be more stable than those that don’t pay dividends because they are returning excess capital to shareholders.
  • When does it perform well?
    High dividend paying stocks perform well in most markets.  They have exhibited particularly strong relative performance versus non-dividend paying equities during bear markets. Valuation matters as well. When prices are low relative to, for example, earnings, subsequent price performance is more likely to be strong.
  • When does it perform poorly?
    High dividend paying stocks may struggle to keep pace during more speculative bull market periods when stock price returns make up a larger portion of total returns, which include dividends plus stock price appreciation. Faster-growing companies that pay little or no dividends may see stronger stock price returns in this type of environment than companies that distribute earnings in the form of dividends rather than investing those earnings back into potential growth.
  • ETF Selection
    ETF Selection
    Name Ticker Operating Expense Ratio
    Primary ETF Schwab U.S. Dividend Equity SCHD 0.06%
    Secondary ETF Vanguard High Dividend Yield VYM 0.06%

    Source: Morningstar Direct, as of 4/30/2020.

    Why these ETFs were selected: Finding the right fit in the high dividend category can be challenging, since a high dividend payment may not be sustainable or may be the result of a falling stock price. However, screens that are too restrictive can result in low yield and sector deviations that are inconsistent with asset class goals.

    At the time of ETF selection, SCHD held approximately 100 stocks with a history of fundamental strength and consistent dividend payments. The portfolio is diversified, as no single stock represents more than 5% of the portfolio and no single sector represent more than 25%. SCHD was selected as the primary ETF because it had one of the lowest expense ratios at the time of ETF selection along with a history of trading with a narrow average bid-ask spread. VYM was selected as the secondary ETF as it provides a diversified portfolio of high dividend paying stocks, while still screening for dividend sustainability (stocks must be forecast to continue paying dividends for the next 12 months). Both ETFs have more than $5 billion in AUM and narrow bid-ask spreads.

    Why other ETFs were not selected: Among other ETFs in this category, Vanguard Dividend Appreciation ETF (VIG) was not selected as the alternate due to more representative asset class coverage by VYM. VIG limits its portfolio to stocks that have increased their dividend for at least 10 years, resulting in a lower yield than either SCHD or VYM. SPDR® S&P Dividend ETF (SDY) and iShares Select Dividend (DVY) had higher expense ratios at the time of ETF selection.

International High Dividend Stocks

  • What is it?
    International high dividend stocks are investments in the equity of foreign companies that tend to distribute higher-than-average dividends. Dividend-paying companies are generally perceived to be more stable than those that don’t pay dividends because they are returning excess capital to shareholders. As with most international assets, investing in international high dividend stocks involves additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets.
  • What role does it play in a portfolio?
    These stocks are well-suited for investors seeking both growth and income from their investments as well as international diversification. These investments offer the same potential benefits as domestic dividend generating securities, plus the added diversification benefits of international exposure.
  • When does it perform well?
    High dividend stocks generally perform competitively with other stocks in most market climates, but tend to outperform relative to other stocks during market downturns. Valuation matters as well. When prices are low relative to, for example, earnings, subsequent price performance is more likely to be strong.
  • When does it perform poorly?
    International developed high dividend stocks may perform poorly in higher return, more speculative markets where capital appreciation accounts for a higher percentage of total return.
  • ETF Selection
    ETF Selection
    Name Ticker Operating Expense Ratio
    Primary ETF Xtrackers MSCI EAFE High Dividend Yield Equity HDEF 0.20%
    Secondary ETF Vanguard International High Dividend Yield VYMI 0.27%

    Source: Morningstar Direct, as of 4/30/2020.

    Why these ETFs were selected: In the international high dividend category, HDEF was selected as the primary ETF because it had the lowest expense ratio while meeting all other criteria at the time of ETF selection. VYMI was selected as the secondary ETF because it had the second-lowest expense ratio while meeting other selection criteria. Both ETFs screen companies for fundamental strength and have historically traded with reasonable bid-ask spreads, considering that international stocks can be less liquid than U.S. stocks.

    Why other ETFs were not selected: Among other ETFs in this category, SPDR S&P Global Dividend (WDIV) includes U.S. investments, and both iShares International Select Dividend (IDV) and Invesco International Dividend Achievers ETF (PID) had higher expense ratios at the time of ETF selection.

Master Limited Partnerships

  • What is it?
    MLPs trade publicly on a securities exchange like stocks and often pay high levels of income. To qualify as an MLP, a partnership must generate at least 90% of its income from what the Internal Revenue Service considers to be “qualifying” sources, including activities related to real estate, or the production, processing or transportation of oil, natural gas, coal and other commodities. Returns on MLPs can be high, but these products also involve risks like more complex tax treatment of cash flows, potential dilution of distributions, and exposure to commodity prices.
  • What role does it play in a portfolio?
    MLPs generate income with growth potential for income-focused portfolios with equity-like risks. They can be used as part of a portfolio’s equity allocation, similar to small-cap stocks, for those who are seeking growth and income, but with higher price volatility than investment-grade bonds.
  • When does it perform well?
    MLPs have tended to perform well during periods of high commodity production, especially oil and gas. While energy MLPs generally generate revenue based on the volume of oil, natural gas, coal or natural gas transported rather than price, the correlation of performance to commodity prices, historically, has been high. Rising commodity prices tend to positively impact production and MLPs, in turn, tend to perform well during these periods. Returns for MLPs also tend to be correlated to returns on stocks. Therefore, when the economy is doing well and equity prices are rising, MLPs generally rise as well.
  • When does it perform poorly?
    MLPs tend to perform poorly when commodity production is declining—which tends to be influenced by commodity prices. Falling commodity prices are generally a negative for MLP returns. Returns for MLPs are also correlated to returns for the stocks. So, when the economy is doing poorly, and equities are declining in price, MLP returns generally suffer. Their prices can also be volatile, at times, given their equity-like characteristics and relative small number of securities in the sector.
  • ETF Selection
    ETF Selection
    Name Ticker Management Fee
    Primary ETF Global X MLP MLPA 0.46%
    Secondary ETF Alerian MLP AMLP 0.85%

    Source: Morningstar Direct, as of 4/30/2020.

    Why these ETFs were selected: The Master Limited Partnership (MLP) asset class can be tricky. Since MLPs are not considered qualified investments for ’40 Act mutual funds (which is how most ETFs are structured), funds must either limit their MLP holdings to less than 25% of the portfolio or structure themselves as C-corporations and withhold and pay corporate income tax. As a result, the expense ratios for C-corporation MLP funds sometimes appear to be much higher than for other ETFs, since estimated tax liabilities are generally included as part of the expense ratio.

    MLPs within Schwab Intelligent Portfolios are limited to those structured as C-corporations, since ETFs with less than 25% of their portfolios allocated to MLPs do not meet the asset class objectives. From among these funds, the two ETFs selected had the lowest management fees at the time of ETF selection, the component of the expense ratio that is set by the funds’ providers (which excludes the impact of anticipated taxes). Both ETFs hold around 20 MLPs. The primary ETF, MLPA, had a management fee of 0.45%. The alternate ETF, AMLP, had a management fee of 0.85%. Neither MLPA nor AMLP issues a K-1 report. These reports can complicate tax filing for clients, so ETFs that issue K-1s are ineligible for Schwab Intelligent Portfolios.

    Why other ETFs were not selected: Some MLP ETFs are not structured as C-Corps and therefore limit MLP exposure to 25% of their portfolios. These types of MLP ETFs do not meet the objectives of this asset class.

 

Fixed Income

US Treasuries

  • What is it?
    Treasuries are debt securities of the US government issued through the US Department of the Treasury at various maturities, from one year or less to as long as 30 years. They generally pay interest on a semi-annual basis, and timely payment of principal and interest is backed by the full faith and credit of the US government, making them among the highest credit-quality investments available. Treasuries are taxable at the federal level but exempt from state and local taxes. Yields on Treasury securities are usually lower than for most other bonds because investors are willing to accept less income in exchange for lower risk. While these bonds are generally considered free from credit risk, they do carry interest rate risk—all else being equal, their prices increase when interest rates fall and vice versa.
  • What role does it play in a portfolio?
    Since Treasuries are considered to be essentially free of credit risk, they provide a secure and predictable source of income, and can be a means of preserving capital. Money that investors want to keep safe from default and stock market risk is often invested in Treasuries. The market for Treasuries is large and liquid, which means that investors can easily buy and sell the securities when they want. By keeping a portion of the portfolio’s assets safe, an allocation to Treasuries in an overall portfolio may allow an investor to take risk in some other part of the portfolio with more confidence. Finally, Treasuries provide diversification from stocks in a portfolio. They often move in the opposite direction of stocks, particularly when the economy is weakening and/or when stocks are falling.
  • When does it perform well?
    Treasuries tend to perform best when inflation is low and interest rates are falling, like all bonds. But they tend to outperform other types of bonds, on a relative basis, when market volatility is high and when the economy is weakening and stock prices are falling.  Investors often put money into Treasuries as a perceived safe haven during times of economic and/or geo-political turmoil due to the high level of safety and liquidity.
  • When does it perform poorly?
    Treasuries tend to perform poorly when inflation and interest rates are rising and market volatility is low. If investors perceive that the economic and financial environment is low risk, then Treasuries are seen as less attractive to hold than other types of investments, such as corporate bonds or stocks. The lower yields for Treasuries make them less attractive to investors when risk and market volatility are low.
  • ETF Selection

    ETF Selection
    Name Ticker Operating Expense Ratio
    Primary ETF Schwab Intermediate-Term U.S. Treasury SCHR 0.05%
    Secondary ETF iShares 3-7 Year Treasury Bond IEI 0.15%

    Source: Morningstar Direct, as of 4/30/2020.

    Why these ETFs were selected: SCHR and IEI provide exposure to intermediate Treasuries and were among the lowest cost funds in this asset class at the time of ETF selection. Both SCHR and IEI had more than $1 billion in assets under management at the time of ETF selection and have historically traded with tight bid-ask spreads.

    Why other ETFs were not selected: Vanguard Total Bond Market (BND) and iShares Core U.S. Aggregate Bond (AGG) are among the largest fixed income ETFs; however, they were not selected because they invest not only in Treasuries but also in other types of securities such as securitized bonds and corporate bonds. PIMCO Active Bond (BOND) is another large fixed income ETF; however, it was not selected because it is an actively managed ETF and also covers a broader range of fixed income securities. Vanguard Intermediate-Term Treasury Index ETF (VGIT) and SPDR Bloomberg Barclays Intermediate Term Treasury ETF (ITE) were not selected because they track the same index as the primary ETF.

US Investment Grade Corporate Bonds

  • What is it?
    US investment grade corporate bonds are investments in the debt of US corporations with relatively high credit ratings provided by one or more of the major US credit rating agencies. Investment grade corporate bonds are those rated BBB- or higher by Standard and Poor’s, or Baa3 or higher by Moody’s Investors Services. That high rating indicates that these bonds have relatively low default risk, and, as a result, the bonds generally pay a lower interest rate than debt issued by entities with below-investment-grade credit ratings. These bonds always pay higher interest than comparable bonds issued by the US Government, all else being equal.
  • What role does it play in a portfolio?
    Investment grade corporate bonds can allow investors to earn higher yields (with more credit risk) than more conservative investments like US Treasuries, with lower credit risk than that of sub-investment grade, or “high yield,” corporate bonds. Credit risk is the risk that a borrower will fail to meet a contractual obligation, resulting in a loss of principal or interest. The higher yields that investment grade corporate bonds offer as compared to Treasuries can help enhance the overall return of a fixed income portfolio. Investment grade corporate bonds also offer diversification benefits. The investment grade corporate bond market is large, with hundreds of issuers and thousands of individual issues, allowing investors to diversify by issuer, industry, maturity and credit rating.

    Investment grade corporate bonds also offer diversification benefits due to relatively low correlation to stocks. Correlation is a statistical measure of how investments have historically moved in relation to one another. Investment grade corporate bonds tend to default less than high yield bonds. The relatively low default rate for investment grade bonds suggests that they can be considered part of an investor’s “core” portfolio. Investment grade corporate bonds trade in the secondary market and their prices can fluctuate. They tend to be more liquid than sub-investment grade corporate bonds and less liquid than Treasuries, but the liquidity can vary depending on each issue. Some bonds trade more actively than others, and when selling you may receive less than your initial investment.

  • When does it perform well?
    Investment grade corporate bonds tend to perform well when the economy is growing and default rates are low and are expected to stay low. In addition to the higher yields that corporate bonds offer, investment grade corporate bonds can appreciate in price as well. The yield advantage that corporate bonds offer relative to Treasuries is called a credit spread; it can be thought of as compensation for the extra risks they have. If the economic outlook is strong or default rates are expected to remain low, investors may accept lower compensation, as the perceived risks of default may decline. When the credit spread falls, the price of corporate bonds generally rises relative to US Treasury bonds.
  • When does it perform poorly?
    Investment grade corporate bonds tend to perform poorly if economic growth slows and defaults are expected to rise. Even though investment grade corporate bonds tend to default significantly less than high yield corporate bonds, investors may demand higher yields to compensate for the potential for a higher rate of corporate defaults. As a result, yields tend to rise relative to Treasuries, pushing prices lower. During periods of market distress, investment grade corporate bonds are generally less liquid than more conservative investments like US Treasuries, which could exacerbate price volatility.
  • ETF Selection

    ETF Selection
    Name Ticker Operating Expense Ratio
    Primary ETF Vanguard Intermediate-Term Corporate Bond VCIT 0.05%
    Secondary ETF SPDR® Portfolio Intermediate Term Corporate Bond SPIB 0.07%

    Source: Morningstar Direct, as of 4/30/2020.

    Why these ETFs were selected: VCIT was selected as the primary ETF because it has an expense ratio that is among the lowest in this asset class at the time of ETF selection along with a share price low enough to allow investors with smaller portfolios to allocate to all asset classes within Schwab Intelligent Portfolios. SPIB was selected for the secondary ETF because of its higher share price. SPIB tracks a market weighted index of investment grade corporate bonds with maturities ranging from 1 to 10 years, while VCIT tracks a similar market weight index albeit with a smaller range of maturities (5-10 years). Both ETFs have large AUM and trade with narrow bid-ask spreads.

    Why other ETFs were not selected: iShares iBoxx $ Investment Grade Corporate Bond (LQD) is one of the largest and most liquid corporate bond ETFs in the marketplace; however, it was not selected because it had a higher expense ratio at the time of ETF selection. CSIA also considers the potential impact to clients such as trading or other costs when selecting an ETF which would replace an existing ETF in the portfolios.

US Securitized Bonds

  • What is it?
    U.S. Securitized bonds are securities in which principal and interest payments are backed by cash flows from a particular asset or pool of assets.  Some of the most common assets used as collateral for these bonds include mortgages, automobile loans and credit card debt. Often these securities will be structured into various groups of assets, or tranches, based on the credit rating of the underlying debt. One type of securitized bond is a mortgage-backed security (MBS). Mortgage-backed securities are created by pooling mortgages purchased from their original lenders. As homeowners make their mortgage payments, those payments get passed on to MBS holders. As a result, mortgage-backed securities generally pay both interest and principal on a monthly basis. If the mortgages in the pool get paid off earlier than expected (from homeowner prepayments) then MBS investors would get their principal back more quickly. Some of the more common types of mortgage-backed securities are those guaranteed by the Government National Mortgage Association (Ginnie Mae) and those issued by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). Ginnie Mae is backed by the full faith and credit of the US government, while MBS issued by Fannie Mae and Freddie Mac are implicitly backed by the US government. However, the US government has no obligation to save either company from default.
  • What role does it play in a portfolio?
    Securitized bonds can help investors earn higher yields than Treasuries, while still investing in high quality investments. And since they generally pay interest and principal on a monthly basis, they can help those investors looking for income. However, the monthly payment can vary, based on the payment speeds of the underlying assets, such as mortgage payments. The uncertainty of monthly payments is one reason why MBS generally pay higher yields than Treasuries. Mortgage-backed securities can also help boost the credit quality of a portfolio, especially those guaranteed by Ginnie Mae. MBS generally have many of the same risks of traditional bonds (such as interest rate risk, credit risk and liquidity risk), but they also come with two unique risks—prepayment risk and extension risk. Prepayment risk occurs when homeowners pay their mortgages back more quickly and then the principal of the MBS gets paid more quickly. Extension risk occurs when homeowners prepay at slower rates, leading to a return of principal that takes longer than initially anticipated.
  • When does it perform well?
    Mortgage-backed securities generally perform well when interest rates are relatively stable or falling. Just like traditional bonds, the price and yields of MBS tend to move in opposite directions. However, because falling interest rates can lead to an increase in prepayments—due to homeowners refinancing their mortgages—the price of mortgage-backed securities might not rise as high as they would have in the absence of a prepayment option. In this case, price appreciation may be tempered, and because of an increase in prepayments, MBS investors are then left to reinvest at lower interest rates.
  • When does it perform poorly?
    MBS perform poorly when interest rates are rising. When interest rates rise, investors are less likely to prepay their mortgages, since they would likely have to refinance at a higher rate. This means that it can take longer to get your money back, meaning it will likely take longer to invest in those higher yields. And like Treasury bonds, higher MBS yields lead to lower prices. If long-term interest rates rise, mortgage-backed securities tend to perform poorly.
  • ETF Selection

    ETF Selection
    Name Ticker Operating Expense Ratio
    Primary ETF Vanguard Mortgage-Backed Securities VMBS 0.05%
    Secondary ETF iShares MBS MBB 0.06%

    Source: Morningstar Direct, as of 4/30/2020.

    Why these ETFs were selected: VMBS and MBB had expense ratios among the lowest in the asset class while also meeting other criteria at the time of ETF selection. While VMBS and MBB track similar indexes of bonds issued by government agencies (e.g. Fannie Mae), VMBS’s index excludes bonds that are not available for trading (in other words the index is “float-adjusted”).

    Why other ETFs were not selected: Other ETFs in the category had higher expense ratios at the time of ETF selection. CSIA considers the potential impact to clients such as trading or other costs when selecting an ETF which would replace an existing ETF in the portfolios.

US Inflation Protected Bonds

  • What is it?
    US inflation protected bonds are securities issued by the US Treasury that protect investors against inflation by adjusting the principal value based on changes in the US Department of Labor’s Consumer Price Index. Like traditional Treasury bonds, they are backed by the full faith and credit of the US government. Inflation protected bonds pay interest on a semi-annual basis, based on a fixed rate at issuance. The actual coupon payment may vary, since that fixed coupon rate is based on principal that adjusts for inflation or deflation. Inflation protected bonds are issued several times a year, with initial maturities of 5, 10, and 30 years. However, due to the passage of time, these bonds can be bought in the secondary market with various maturities. The principal value rises with inflation, and falls with deflation. The coupon payment is always based on the adjusted principal, even if it falls below its initial par value due to deflation. However, at maturity, investors will always receive the greater of the adjusted par value or its initial par value. In other words, the initial principal amount of an inflation protected bond is protected from deflation, but the coupon payments are not.
  • What role does it play in a portfolio?
    In 1997, the US Treasury introduced inflation protected bonds as a means of protecting against the corrosive impact of inflation. With these bonds, the principal value adjusts upward with inflation, and downward with deflation.  Inflation protected bonds can be a good addition to a fixed income portfolio for investors to help protect against the impact of inflation on their fixed income holdings.
  • When does it perform well?
    US inflation protected bonds generally perform well when inflation rises, since the principal and coupons would both rise as well. The bonds may also perform well when inflation expectations rise, as investor demand can push the prices higher relative to traditional US Treasuries, as investors seek inflation protection. Inflation protected bonds are still bonds whose prices and yields move in opposite directions. If traditional Treasury bond yields are falling, inflation protected bonds’ yields may follow suit, pushing prices higher.
  • When does it perform poorly?
    Inflation protected bonds generally perform poorly if inflation is declining, outright deflation takes hold, or inflation expectations decline. If expectations for future inflation are tame, investors may prefer traditional Treasury bonds, pushing inflation protected bond prices lower. Also, if Treasury yields rise without an accompanying rise in inflation, inflation protected bond prices would likely fall as well.
  • ETF Selection
    ETF Selection
    Name Ticker Operating Expense Ratio
    Primary ETF Schwab U.S. TIPS SCHP 0.05%
    Secondary ETF SPDR Portfolio TIPS SPIP 0.12%

    Source: Morningstar Direct, as of 4/30/2020.

    Why these ETFs were selected: SCHP and SPIP both hold Treasury inflation-protected securities (TIPS) issued by the U.S. Treasury and representing a broad range of durations. These two funds each had more than $1 billion in assets under management and both ETFs have a history of closely tracking their underlying indexes and trading with relatively narrow bid-ask spreads.

    Why other ETFs were not selected: iShares TIPS Bond (TIP) is the largest ETF in the category but had a higher expense ratio at the time of ETF selection. Among other ETFs in this category, Vanguard Short-Term Inflation-Protected Securities ETF (VTIP) and iShares 0-5 Year TIPS Bond ETF (STIP) limit their holdings to short durations.

US Corporate High Yield Bonds

  • What is it?
    US corporate high yield bonds—sometimes known as “junk bonds”—are investments in the debt of US corporations with lower credit ratings provided by the major US credit rating agencies. High yield bonds have ratings of BB+ or below by Standard and Poor’s and Ba1 or below by Moody’s Investors Services. That low rating indicates that these companies have relatively high default risk, meaning that the issuer is much more likely to not be able to meet its debt payment obligation as compared to an investment grade bond. Because these bonds are riskier than those issued by entities with investment-grade credit ratings, they generally pay a higher interest rate than a comparable investment grade bond.
  • What role does it play in a portfolio?
    High yield corporate bonds generally offer higher yields than investment grade corporate bonds, so they offer the potential to enhance the total return of a portfolio even more. Like investment grade corporate bonds, high yield corporate bonds allow investors to diversify by issuer, industry, maturity, and credit rating, among others. However, the diversification benefits that high yield corporate bonds offer are different from investment grade corporate bonds. High yield bonds have therefore tended to behave like stocks in times of distress, and might not necessarily help protect the downside like US Treasuries or investment grade corporates might.

    High yield corporate bonds enjoy a yield advantage—called a credit spread—over comparable US Treasuries, and the advantage is more than investment grade corporate bonds, though high-yield bonds also come with a greater risk of default. The high yield bond market is smaller than that of the investment grade corporate bond market, and the deal size of high yield bonds is smaller than that of investment grade corporate bonds, on average. This reduces the overall liquidity and leads to greater volatility for high yield corporate bonds.

  • When does it perform well?
    High yield corporate bonds tend to perform well when the economy is strong and default rates are low and are expected to remain low. In addition to the higher yields that corporate bonds offer, high yield corporate bonds can experience price appreciation as well. The yield advantage that corporate bonds offer relative to Treasuries is called a credit spread; it can be thought of as compensation for the extra risks they have. If the economic outlook is strong or default rates are expected to remain low, investors may accept lower compensation, as the perceived risks of default may decline. When the credit spread falls, the price of corporate bonds generally rises relative to US Treasury bonds.
  • When does it perform poorly?
    High yield corporate bonds tend to perform poorly if economic growth slows and defaults are expected to rise. High yield corporate bonds tend to be much less liquid than investment grade corporate bonds, and are much more prone to significant sell-offs.
  • ETF Selection
    ETF Selection
    Name Ticker Operating Expense Ratio
    Primary ETF Xtrackers USD High Yield Corporate Bond HYLB 0.15%
    Secondary ETF iShares Broad USD High Yield Corporate Bond USHY 0.22%

    Source: Morningstar Direct, as of 4/30/2020.

    Why these ETFs were selected: HYLB and USHY had the lowest net expense ratios (which exclude fees waived by the fund providers) among eligible ETFs in this category at the time of ETF selection. Both HYLB and USHY contain high yield corporate bonds with a broad range of durations. Each of these ETFs had sizable assets under management at the time of ETF selection and a history of trading with reasonable bid-ask spreads.

    Why other ETFs were not selected: iShares iBoxx $ High Yield Corporate Bond (HYG) and SPDR Bloomberg Barclays High Yield Bond ETF (JNK) are the largest ETFs in this category but had significantly higher expense ratios at the time of ETF selection. iShares Fallen Angels USD Bond ETF (FALN) and VanEck Vectors Fallen Angel High Yield Bond ETF (ANGL) were not selected due to sector and duration profiles that differ significantly from our strategic benchmarks.

International Developed Country Bonds

  • What is it?
    International developed country bonds are debt instruments issued by a government, agency, municipality or corporation domiciled in a highly developed country other than the U.S. They may be issued in the home currency of the country of origin or denominated in U.S. dollars or some other currency. International developed country government bonds typically carry investment grade credit ratings, but some may be rated below investment grade. Corporate bonds issued in developed market countries may be investment grade or sub-investment grade.
  • What role does it play in a portfolio?
    International developed market bonds share several characteristics of securities issued by the U.S. government and corporations, but also offer geographic diversification benefits and exposure to international markets that may be at a different stage of the business cycle than the U.S. at any given time. If the bonds are denominated in a foreign currency, there can be a benefit from diversification from the U.S. dollar if the dollar is declining.
  • When does it perform well?
    International developed market bonds tend to perform well when the U.S. dollar is declining against other major currencies and/or interest rates in the U.S. are low relative to other major countries. As with all bonds, performance is strongest when interest rates and inflation are falling. When foreign bond yields are higher than U.S. yields for comparably rated bonds of similar maturity, investors often buy foreign bonds to capture the more attractive yields. They have also historically performed well when the U.S. stock market is declining, as that often leads investors to shift out of U.S. securities and into other markets.
  • When does it perform poorly?
    International developed market bonds tend to perform poorly when the U.S. dollar is rising and/or interest rates and inflation are rising. Country specific events can affect the performance of international bonds as well, such as rising government budget deficits or adverse political developments. Monetary policies also affect the performance of international developed country bonds, both in terms of the direction of interest rates and credibility. A country with a central bank that has a history of managing inflation well may pay less interest on its bonds than one where lax central bank policies have allowed inflation to be higher. International corporate bonds, much like U.S. corporate bonds, tend to perform poorly when the issuing company is experiencing poor growth in earnings or perhaps has increased its balance sheet leverage through high borrowing.
  • ETF Selection
    ETF Selection
    Name Ticker Operating Expense Ratio
    Primary ETF Vanguard Total International Bond BNDX 0.08%
    Secondary ETF iShares Core International Aggregate Bond IAGG 0.09%

    Source: Morningstar Direct, as of 4/30/2020.

    Why these ETFs were selected: Both BNDX and IAGG offer currency-hedged exposure to international bonds issued by both governments and corporations in developed markets. By hedging currency exposure to the U.S. dollar, these funds aims to capture interest rate differentials (i.e. higher interest rates in foreign markets as compared to those in the U.S.) without exposing U.S. investors to volatile currency fluctuations. Additionally, both funds are broadly diversified by maturity and overwhelmingly investment grade. They also trade with bid-ask spreads within our acceptable range.

    Why other ETFs were not selected: The category consists of just two ETFs that meet asset class objectives and other criteria.

International Emerging Market Bonds

  • What is it?
    International emerging market bonds (EM bonds) are issued by a government, agency, municipality or corporation domiciled in a developing country. These investments typically offer higher yields to reflect the elevated risk of default, which can stem from underlying factors such as political instability, poor corporate governance and currency fluctuations. The asset class is relatively new compared with other sectors of the bond market. Indices that track EM bonds only date back to the 1990s when the market became liquid and actively traded. EM bonds may be denominated in local currency or in U.S. dollars or other major currencies. While some EM countries have taken on the characteristics of developed market economies, with more stable fiscal and monetary policies and sounder financial institutions, there remain wide differences among the countries categorized as emerging markets.
  • What role does it play in a portfolio?
    An allocation to EM bonds can provide investors with a source of higher income than developed market bonds might offer and the potential for capital appreciation. The potential upside, however, comes with more risk. Defaults among EM bonds have historically been higher than for developed market bonds. EM bonds tend to be more highly correlated with equities than with U.S. Treasuries or developed market international bonds. EM bonds, if denominated in local currency, can provide another source of diversification in a portfolio. However, EM currencies also tend to be much more volatile than developed market currencies. Corporate bonds issued by companies in EM countries can offer access to fast-growing economies with higher yields than might be available in developed market corporate bonds.
  • When does it perform well?
    EM bonds tend to perform well when the U.S. dollar and other major currencies like the euro or Japanese yen decline because EM assets look more attractive by comparison. A growing global economy tends to benefit EM country bonds as well since exports generally represent a bigger proportion of EM economies. A low interest rate, low volatility environment has also tended to be positive for EM bonds because investors are attracted to the higher interest rates EM bonds offer.
  • When does it perform poorly?
    In addition to the factors that contribute to the poor performance of developed country bonds, EM bonds tend to perform poorly when investors are averse to taking risk or when global growth slows. Since many EM countries derive much of their growth from exports to developed countries, slower growth in trade globally tends to be a negative factor for the economies and currencies of EM countries.
  • ETF Selection
    ETF Selection
    Name Ticker Operating Expense Ratio
    Primary ETF SPDR® Bloomberg Barclays Emerging Markets Local Bond EBND 0.30%
    Secondary ETF VanEck Vectors JP Morgan EM Local Currency Bond EMLC 0.30%

    Source: Morningstar Direct, as of 4/30/2020.

    Why these ETFs were selected: EBND and EMLC had expense ratios which are among the lowest in this asset class at the time of ETF selection. Both EBND and EMLC have a history of trading with reasonable bid-ask spreads (which can be difficult to do in the EM bond space).

    Why other ETFs were not selected: In Morningstar’s US Fund Emerging-Markets Local Currency Bond category, there are also single-country and single region options (e.g. CBON and KCNY). We did not select any of these ETFs as they do not match our strategic benchmark and fail to meet the asset class objectives.

Preferred Securities

  • What is it?
    Preferred securities are a “hybrid” investment, sharing characteristics of both stocks and bonds. In recent years, the term “preferred securities” has often been used as a blanket term to encompass anything from $25 par senior debt to traditional preferred stock. Like stocks, they are generally paid after a company’s bonds in the event of a corporate liquidation. Like bonds, however, they generally make regular fixed payments and have a par value that can rise or fall as interest rates change. Preferred securities are senior to common stock – meaning their holders have priority over holders of common stock in the event of a claim on the company’s assets – and some rank as high as senior unsecured bonds. This asset class is “preferred” because holders of such securities have claim on the company’s earnings before dividend payments can be made on common stock. Preferred securities generally offer higher yields than traditional fixed income securities like bonds. Preferred securities often have very long maturities – usually 30 years or more – or no maturity date at all, meaning they are perpetual. However, most preferred securities have “call” features, allowing the issuing firm to retire them, at their par value, before maturity. Due to the perpetual nature of some preferred securities, there’s no guaranteed return of principal. The prices of preferred securities can fluctuate, so investors needing to sell might receive less than their initial investment if they sell in the secondary market. Also, companies can suspend or cancel a preferred dividend payment at will, without facing the consequences of a default.
  • What role does it play in a portfolio?
    Preferred securities can help investors earn a higher yield and potentially enhance the overall total return of a portfolio. However, they do come with some unique risks. An issuer’s preferred securities will usually have a lower credit rating than the firm’s senior, unsecured bonds, due to the weaker guarantees of the income payments. Also, preferred securities tend to be issued by financial institutions, meaning it’s difficult to have a preferred securities portfolio that is well diversified among various sectors. And there are significantly fewer preferred securities issuers than there are corporate bond issuers, so it’s more difficult to be diversified by issuer as well.
  • When does it perform well?
    Preferred securities tend to do best when long-term bond yields are stable or falling, and the economic outlook is positive. Preferred securities have two key risks: interest rate risk and credit risk. If long-term interest rates are falling, the prices of preferred securities would likely rise. Preferred securities tend to have high durations, a measure of interest rate sensitivity, so their prices are very sensitive to a fall in interest rates. Also, preferred securities may perform well when investors demand less of a credit spread to hold them, which would push their prices higher relative to U.S. Treasuries.
  • When does it perform poorly?
    Preferred securities tend to do poorly when long-term interest rates are rising, due to their relatively high durations. Preferred securities also tend to do poorly when the perceived credit risk of the corporate market increases, as the risk rises that issuers could suspend the dividend or interest payments.
  • ETF Selection
    ETF Selection
    Name Ticker Operating Expense Ratio
    Primary ETF Global X US Preferred PFFD 0.23%
    Secondary ETF SPDR Wells Fargo Preferred Stock PSK 0.45%

    Source: Morningstar Direct, as of 4/30/2020.

    Why these ETFs were selected: PFFD and PSK were selected as the primary and alternate ETFs because each provides broad, diversified exposure to this asset category and has traded historically with a relatively narrow average bid-ask spread. Our primary ETF, PFFD is also the lowest cost ETF in this asset class.

    Why other ETFs were not selected: VanEck Vectors Preferred Securities ex Financials ETF (PFXF) excludes securities of financial institutions. These securities make-up as much as 75% of the preferred market, so PFXF did not provide the intended broad asset class coverage. Invesco Preferred ETF (PGX) and Invesco Financial Preferred ETF (PGF) had higher expense ratios at the time of ETF selection.

Bank Loans

  • What is it?
    Bank loans are originated by banks and sold to institutional investors like mutual funds or ETFs. The loans are made to corporations, which use them to fund acquisitions and other strategic initiatives. The loans typically have floating rates, meaning they pay a set amount over a benchmark interest rate, often the 3-month London Interbank Offered Rate (Libor). Bank loans are generally rated below investment grade, meaning BB+ or below by Standard & Poor’s or Ba1 or below by Moody’s Investors Services. Bank loans are usually “secured,” which means that they are backed by a pledge of the issuer’s assets, such as inventories or receivables. And they are generally senior to most other corporate debt; so in default, they would get paid before the issuer’s other corporate bonds. Due to bank loans’ senior and secured status, they generally have higher recovery rates in the case of a default. Since bank loans are rated below investment grade, they generally carry higher yields than investment grade corporate bonds.
  • What role does it play in a portfolio?
    Under certain conditions, these types of loans and notes can be attractive to investors who think short-term interest rates may rise. Since they are rated below investment grade, they should be considered an aggressive investment relative to other types of fixed income. The coupons are tied to short-term interest rates. If long-term interest rates rise, the coupons on bank loans would likely be unaffected. Also, most bank loans have a “Libor floor,” which is the minimum rate for Libor on which the coupon will be based. This means that Libor would need to rise to that level before the coupons started to adjust higher.
  • When does it perform well?
    Bank loans tend to perform well when short-term interest rates—specifically 3-month Libor—are rising and default rates remain low. In this scenario, investors can benefit from higher coupons payments, with less risk of prices falling due to defaults. Bank loans also perform well when market volatility is lower, since they tend to suffer from low liquidity.
  • When does it perform poorly?
    Bank loans can perform poorly when short-term interest rates are falling. In this scenario, the coupon payments would decline, likely reducing the total return. Bank loans tend to perform poorly when the economy is expected to slow and defaults rates are rising or expected to rise. Despite their “senior, secured” status, bank loans are still aggressive investments.
  • ETF Selection
    ETF Selection
    Name Ticker Operating Expense Ratio
    Primary ETF Invesco Senior Loan BKLN 0.65%
    Secondary ETF N/A N/A N/A

    Source: Morningstar Direct, as of 4/30/2020.

    Why this ETF was selected: There are two ETFs in the bank loan space that are passively managed. BKLN is currently the only ETF in this asset class that meets our eligibility criteria. BKLN has large assets under management and has historically traded at a relatively narrow bid-ask spread.

    Why other ETFs were not selected: No other ETFs in this asset class met our eligibility criteria.

Investment Grade Municipal Bonds

  • What is it?
    Investment grade municipal bonds are investments in bonds issued by municipalities—cities, states, counties—as well as enterprises that serve a public purpose, such as universities, hospitals and utilities. These investments generally have high credit ratings from various rating agencies. The coupon payments made by these bonds are typically exempt from federal and state income tax (if issued by a municipality located within the resident’s state). However, other taxes may apply.  For example, tax-exempt income may be subject to the Alternative Minimum Tax (AMT), capital appreciation from bond funds and discounted bonds may be subject to state or local taxes, and capital gains are not exempt from federal income tax. Despite the high-profile credit problems of some municipalities, almost all US cities have been able to cut spending or increase revenue to support payments even during tough economic times, and so historically, defaults for investment-grade municipal bonds have been exceedingly rare. In fact, between 1970 and 2017, less than 100 municipal issuers rated by Moody’s defaulted.
  • What role does it play in a portfolio?
    Investment grade municipal bonds combine strong historic credit-worthiness and tax advantages. Interest income earned on most municipal bonds is not subject to federal taxes, an advantage compared to corporate and Treasury bonds for investors in higher tax brackets or investing in taxable accounts. Like other bonds, they often move in the opposite direction of stocks, so they can provide diversification benefits as well as income.
  • When does it perform well?
    Like most bonds, investment grade municipal bonds tend to perform best when interest rates are falling and inflation is low. Money used to pay municipal bonds tends to be tied to tax revenues or usage fees so they often perform well when the economy is improving and tax receipts or usage is high. Municipal bonds tend to perform similarly to Treasury and corporate bonds, based on changes in market interest rates. Other factors, however, can cause differences in performance including higher or lower demand for the tax advantages. Already issued municipal bonds often tend to trade infrequently compared to many other fixed income markets. Therefore, municipal bonds may also do well compared to other fixed income investments when the amount of newly issued municipal bonds is low because the scarce supply can drive prices up.
  • When does it perform poorly?
    When interest rates are rising or inflation is high, investment grade municipal bonds tend to perform poorly. They also tend to perform poorly when, among other things, municipal credit conditions are deteriorating (often driven by lower tax revenues or higher municipal expenses). The municipal bond market is also more prone to headline risk—or the risk that investors will sell their investments due to a single negative event that is not actually impacting the rest of the market—compared to other markets. Because municipal bonds pay interest that is generally exempt from federal taxes, lower federal tax rates make municipal bonds less attractive compared with other taxable fixed income investments because it reduces the benefit of the tax exemption. While the municipal bond market has a lot of debt outstanding, the size of this market is much smaller than others such as U.S. Treasuries. This smaller size increases the potential liquidity risk, which can drive down prices when selling into an illiquid market.
  • ETF Selection
    ETF Selection
    Name Ticker Operating Expense Ratio
    Primary ETF Vanguard Tax-Exempt Bond VTEB 0.06%
    Secondary ETF SPDR® Nuveen Bloomberg Barclays Municipal Bond ETF TFI 0.23%

    Source: Morningstar Direct, as of 4/30/2020.

    Why these ETFs were selected: Among the eligible ETFs in this category, VTEB is the ETF with the lowest expense ratio that met all other criteria at the time of ETF selection. TFI has the second lowest expense ratio among ETFs that provide exposure to broad duration munis and tracks an index that is not identical to the primary ETF.

    Why other ETFs were not selected: iShares National Muni Bond ETF (MUB) is the largest ETF in this category but tracks an index that is identical to the primary ETF and therefore not suitable for tax loss harvesting. VanEck Vectors AMT-Free Intermediate Muni ETF (ITM) and Invesco National AMT-Free Muni Bond ETF (PZA) had higher expense ratios at the time of ETF selection.

Investment Grade California Municipal Bonds

  • What is it?
    Investment grade California municipal bonds are investments in bonds issued by municipalities and enterprises in the State of California. These investments generally have high credit ratings from various rating agencies. The coupon payments made by these bonds are exempt from federal and California state income tax for California residents.  However, other taxes may apply.  For example, tax-exempt income may be subject to the Alternative Minimum Tax (AMT), capital appreciation from bond funds and discounted bonds may be subject to state or local taxes, and capital gains are not exempt from federal income tax. Despite the high-profile credit problems of some municipalities, most US cities have been able to cut spending or increase revenue to support payments even during tough economic times, and so historically, defaults for investment-grade municipal bonds have been exceedingly rare.
  • What role does it play in a portfolio?
    Investment grade municipal bonds combine strong historical credit-worthiness and tax advantages, with an additional tax advantage for California residents. Like most other bonds, they tend to have lower correlations with stocks, so they can also provide diversification benefits.
  • When does it perform well?
    Like most municipal bonds, investment grade California municipal bonds tend to perform best when interest rates are falling and inflation is low. Money used to pay municipal bonds tends to be tied to tax revenues or usage fees so they often perform well when the economy is improving and tax receipts or usage is high. Already issued municipal bonds often tend to trade infrequently compared to many other fixed income markets. Therefore, municipal bonds in general may also tend to perform well compared to other fixed income investments when the amount of newly issued municipal bonds is low because the scarce supply can drive prices up.
  • When does it perform poorly?
    When interest rates are rising or inflation is high, investment grade California municipal bonds tend to perform poorly. They also tend to perform poorly when the local economy is deteriorating. This can impact tax revenue or usage fees, which are generally tied to the source of repayments for municipal bonds. Compared with other markets, the municipal bond market is also more prone to headline risk—or the risk that investors will sell their investments due to a single negative event that is not actually impacting the rest of the market. While California has a large amount of debt outstanding, the size of its market is much smaller than others such as U.S. Treasuries. This smaller size increases potential liquidity risk, which can drive down prices when selling into an illiquid market.
  • ETF Selection
    ETF Selection
    Name Ticker Operating Expense Ratio
    Primary ETF iShares California Muni Bond CMF 0.25%
    Secondary ETF Invesco California AMT-Free Municipal Bond PWZ 0.28%

    Source: Morningstar Direct, as of 4/30/2020.

    Why these ETFs were selected: These are the only two ETFs meeting all selection criteria that provide dedicated exposure to California municipal bonds. PWZ and CMF have both traded historically with reasonable bid-ask spreads. Both funds are AMT-free.

    Why other ETFs were not selected: There were no other ETFs meeting all selection criteria in this category at the time of ETF selection.

Commodities

Gold and Other Precious Metals

  • What is it?
    Precious metals include gold, silver, platinum, and other precious metals.
  • What role does it play in a portfolio?
    This asset class adds diversification to a portfolio and is typically considered defensive because of its tendency to perform well when financial assets (e.g., stocks and bonds) perform poorly.
  • When does it perform well?
    Precious metals tend to perform well when expectations for future inflation are increasing, the U.S. dollar is falling, geopolitical unrest is rising, or there are widespread concerns about the stability of the financial system.
  • When does it perform poorly?
    Precious metals tend to perform poorly when expectations for future inflation are decreasing, the U.S. dollar is rising, geopolitical unrest is falling, or concerns about financial system stability are declining.
  • ETF Selection

    ETF Selection
    Name Ticker Operating Expense Ratio
    Primary ETF iShares Gold Trust IAU 0.25%
    Secondary ETF Aberdeen Standard Physical Precious Metals Basket Shares GLTR 0.60%

    Source: Morningstar Direct, as of 4/30/2020.

    Why these ETFs were selected: Commodities exposure within Schwab Intelligent Portfolios is limited to gold and other precious metals because ETFs that focus on other commodities tend to be structured as exchange traded notes (ETNs) and/or issue K-1 reports, making them ineligible for the program. In the precious metals category, IAU was selected as the primary ETF because it has an expense ratio that is among the lowest in the asset class while meeting all of the other criteria at the time of ETF selection. GLTR was selected as the secondary ETF because it does not focus on the exact same assets, which is necessary for tax loss harvesting purposes. IAU’s portfolio consists entirely of gold bars held in vaults around the world, while GLTR’s portfolio also includes silver, platinum and palladium and is held in vaults in London and Zurich.

    Why other ETFs were not selected: CSIA considers the potential impact to clients such as trading or other costs when selecting an ETF which would replace an existing ETF in the portfolios.

 

FDIC-insured Cash

  • What is it?
    The FDIC-insured cash allocationin Schwab Intelligent Portfolios is invested in the Schwab Intelligent Portfolios Sweep Program, which is sponsored by Charles Schwab & Co., Inc. By enrolling in Schwab Intelligent Portfolios, clients consent to having the free credit balances in their brokerage accounts swept to deposit accounts at Schwab Bank. These deposit accounts will earn interest at a rate that will be greater of (i) the rate determined by reference to a third party index for retail deposits at the $100,000 level based on a survey as calculated by RateWatch; or (ii) the rate paid on cash balances of $1,000,000 or more in Schwab’s bank sweep program for brokerage accounts. See the current interest rate by going to schwab.com/intelligent-cashrate.
  • What role does it play in a portfolio?
    Cash investments play an important role within a well-diversified investment portfolio and serve several purposes, including greater stability, diversification and potential inflation protection. Schwab Intelligent Portfolios includes cash as an investment to help provide a stable foundation within an overall asset allocation that includes other asset classes such as equities, bonds and commodities. Cash allocations are determined according to an investor’s risk profile, with the most risk-averse or short-term portfolios holding the highest levels of cash and the least risk-averse or longer-term ones holding the lowest levels of cash. A meaningful cash allocation provides stability to help mitigate downside risk. Lower portfolio risk can help moderate downturns and keep investors focused on their longer-term goals rather than overreacting to short-term market movement.
  • When does it perform well?
    Cash tends to do well relative to other asset classes during periods of rising interest rates because its duration is so short. Cash is also a member of the “defensive asset” club. The price movements of defensive assets generally have low or negative correlations with those of equity securities. Defensive asset classes tend to perform well when there is downward pressure on equities. What makes cash unique among other defensive assets is that it has the lowest price volatility of the group. Other defensive assets (e.g., gold) have a great deal of price volatility associated with them.
  • When does it perform poorly?
    Cash may underperform in a very low interest rate environment where the central bank is keeping short-term interest rates low to stimulate economic growth, such as in the aftermath of the US financial crisis. Since cash is very liquid, the rate paid to investors is generally low compared to the yield on other securities.

1. Tax-loss harvesting is available for clients with invested assets of $50,000 or more in their account. Clients must choose to activate this feature.

2. For more information about tax-loss harvesting and the role of the primary and secondary ETFs, please see the white paper “Tax-Loss Harvesting and Rebalancing” on the Schwab Intelligent Portfolios website.

3. Arnott, R; V. Kalesnik, P. Moghtader and C. Scholl, “Beyond Cap Weight: The empirical evidence for a diversified beta,” Journal of Indexes, January/February 2010.

4. Arnott, R; V. Kalesnik, P. Moghtader and C. Scholl, “Beyond Cap Weight: The empirical evidence for a diversified beta,” Journal of Indexes, January/February 2010.

5. Arnott, R; V. Kalesnik, P. Moghtader and C. Scholl, “Beyond Cap Weight: The empirical evidence for a diversified beta,” Journal of Indexes, January/February 2010.

6. Arnott, R; V. Kalesnik, P. Moghtader and C. Scholl, “Beyond Cap Weight: The empirical evidence for a diversified beta,” Journal of Indexes, January/February 2010.

7. Arnott, R; V. Kalesnik, P. Moghtader and C. Scholl, “Beyond Cap Weight: The empirical evidence for a diversified beta,” Journal of Indexes, January/February 2010.

8. Arnott, R; V. Kalesnik, P. Moghtader and C. Scholl, “Beyond Cap Weight: The empirical evidence for a diversified beta,” Journal of Indexes, January/February 2010.

9. The cash allocation in Schwab Intelligent Portfolios Solutions will be accomplished through enrollment in the Schwab Intelligent Portfolios Sweep Program (Sweep Program), a program sponsored by Charles Schwab & Co., Inc. By enrolling in Schwab Intelligent Portfolios Solutions, clients consent to having the free credit balances in their Schwab Intelligent Portfolios Solutions brokerage accounts swept to deposit accounts at Charles Schwab Bank through the Sweep Program. Funds deposited at Charles Schwab Bank are insured, in aggregate, up to $250,000 per depositor, for each account ownership category, by the Federal Deposit Insurance Corporation (FDIC). Charles Schwab Bank is an FDIC‐insured depository institution affiliated with Charles Schwab & Co., Inc. and Charles Schwab Investment Advisory, Inc.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. All expressions of opinion are subject to change without notice in reaction to shifting market, economic, and political conditions. Past performance does not guarantee future results.

It should not be assumed that investment in the ETFs listed or discussed were or would be profitable.

Investing involves risks including possible loss of principal.

Diversification, automatic investing, and rebalancing strategies do not ensure a profit and do not protect against losses in declining markets.

Schwab Intelligent Portfolios® and Schwab Intelligent Portfolios Premium™ are designed to monitor portfolios on a daily basis and will also automatically rebalance as needed to keep the portfolio consistent with the client’s selected risk profile. Trading may not take place daily.

Charles Schwab & Co., Inc. and Charles Schwab Bank are separate but affiliated companies and subsidiaries of The Charles Schwab Corporation. Brokerage products, including the Schwab One brokerage account, are offered by Charles Schwab & Co., Inc., Member SIPC. Deposit and lending products are offered by Charles Schwab Bank, Member FDIC and an Equal Housing Lender.

(1020-06ZC)

 

Source: Guide to Asset Classes & ETFs

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investing – personalfinance

Source: investing – personalfinance

 

Common Questions on Investing

I have money that I need in a short amount of time. Should I invest?

It’s a bad idea to invest money that you will need within several years. The stock market is too volatile for any time horizon shorter than 3 to 5 years and investing for less than 10 years is risky (it’s not for the faint of heart).

  • For any time frame under 3 to 5 years, you should just use savings or money market accounts. If the idea of low interest rates is too much to bear, you can also consider using I Bonds or laddered CDs. The issue with using I Bonds is that your purchase is locked up for the first 12 months. CDs also often have a lock up period or a significant early withdrawal penalty.
  • If the time frame is 5 years or longer, you can consider something like a Vanguard LifeStrategy fund or a similarly allocated three-fund portfolio. The risk is significant that you will lose money because it’s a relatively short time frame for an investment that is based on stocks and bonds. You need to be prepared for a scenario where a poorly timed downturn could affect your plans for the money. To put it another way: More than half of the time, it will be a win (based on past history), but sometimes it will not be a win.

    If that seems too risky for you, stick with savings accounts, money market accounts, CDs, or maybe some I Bonds (as long as the 12-month lockup isn’t an issue, see above).

    Just bear in mind that there is a different risk to not investing aggressively enough. If your investments are not outpacing inflation (about 2% a year in recent history), you may be losing actual value over time despite your investments being worth more nominally. Historically, stocks tend to outpace inflation the best. Bonds also generally outpace inflation, but the margin tends to be significantly smaller.

  • For borderline time frames of 3 to 5 years, aggressive investors may consider one of the more conservative Vanguard LifeStrategy funds or a similarly allocated three-fund portfolio (perhaps combined with I Bonds, CDs, saving accounts, and/or money market accounts), but this is definitely not for the faint of heart!

What types of accounts should I save in?

  • Note: the type of account is completely separate from the investment itself (except that certain accounts can only contain certain kinds of investments). The account type depends on the type of financial goal you’re saving for, since different account types have different rules about how/when you can use the money, and how they are taxed. Pick the account type based on the type of financial goal. Pick the investment based on the time horizon for that goal.
  • Put your emergency fund in a savings or checking account, ideally at a bank with no ATM fees and lots of convenient ATMs
  • Save for retirement in tax-advantaged retirement accounts such as an IRA, 401(k), 403(b), or the Thrift Savings Plan. In general, the financial optimum is to “use up” all available tax-advantaged retirement account space before moving on to investing in taxable investment accounts. See Roth or Traditional? for information on deciding between the “Roth” version and “traditional” version of retirement accounts.
  • Save for all other financial goals in a taxable brokerage account.
  • For specialty savings accounts, consider 529 plans (education), Health Savings Accounts (for future medical expenses, if your health insurance plan qualifies you for one), or UGMA/UTMA accounts for children.

What should I invest in?

If you’ve already decided to invest your money, and you’ve decided what type of account to invest in (don’t skip these steps!), you now need to determine the investments themselves!

Diversify by holding different types of assets.

It may be unwise to only hold stocks of U.S. large companies. Most people would recommend diversifying across US stocks, international stocks, and bonds. See the Bogleheads wiki article on asset allocation for more. An example asset allocation for someone with a long investment timeframe might be 50% US stocks, 30% international stocks, and 20% bonds.

Diversify by holding funds, not individual securities.

It is the general philosophy of the /r/personalfinance community that the best approach to investing, especially for beginners, takes advantage of diversified funds of stocks and bonds. Instead of purchasing shares of specific companies (like Coke), you buy into mutual funds or exchange traded funds, which in turn own hundreds or thousands of companies. In this way, you get the upside benefit of the general trend of stock markets to go up, and eliminate the extreme volatility and risk that can come with holding single stocks. Good brokers to purchase shares of index funds from include Vanguard, Fidelity, and Charles Schwab.

Prioritize funds with low expenses.

In general, stock and bond funds can be divided into two categories:

  1. Actively managed funds. These funds have a management team that is actively picking and choosing, buying and selling stocks in an attempt to “beat the market” and “buy low, sell high”. Unfortunately, they often come with much higher fees.
  2. Index funds hold stocks or bonds according to an “index” (like the S&P 500) and don’t change at all (except when the index changes, rarely). Due to this, the expenses are often much lower. (Expense ratios below 0.3%, no sales loads).

Research continues to show that in general, people holding low expense index funds out perform people holding actively managed funds (source). You can’t predict the future, and the past performance of any given mutual fund is no indicator of future performance. One of the few things you can control when selecting investments is the expenses you pay.

Two main types of expenses associated with mutual funds and ETFs:

Type of Expense Description Example “Ideal” Expense
Expense Ratio the percentage of your assets that is skimmed off each year to pay the management team If the underlying assets of a mutual fund see a 6% gain in a year, but the fund has a 0.5% expense ratio, your holdings will only increase about 5.5% in value. less than 0.18%. This is readily achievable through low cost internet brokers like Fidelity, Schwab, or Vanguard.
Sales “Load” a sales charge you pay every time you buy (or sell) shares. If you put $1,000 into a mutual fund with a 5% front load, your money only buys $950 worth of shares in that fund. It may take a year or more to make up that loss! 0%. Paying any sales charge at all should be unnecessary.

How can I start investing for retirement?

  • If you want something simple to start and you have income to invest, save $1,000 and open a Roth or Traditional (depending on your tax circumstances) IRA with Vanguard or Schwab (see below for fund suggestions).
  • Another important thing to do is to read about investing for retirement. Check out the suggested reading list and follow threads in /r/personalfinance about the topic. Ask questions as they come up if they aren’t in the wiki.

Should I invest a lump sum all at once, or employ a dollar cost averaging strategy?

  • Dollar cost averaging (DCA) is a strategy in which you spread out your investment of a given sum over time. For example, if you have $12,000 to invest, you could invest $3,000 every quarter, $1,000 every month, or any other increment you want. DCA reduces your short-term risk by ensuring that your entire sum is not invested at temporarily inflated prices.
  • However, it is important to understand that DCA is not the financially optimal strategy. Vanguard found that lump sum investing (LSI), i.e. investing all of your available funds immediately, outperformed a DCA strategy based on historical performance (PDF 12). Since the long-term historical trend of equities has been “up,” this makes sense intuitively as well – lump sum investors are compensated for taking on the equity risk premium (“high risk, high reward”) sooner rather than later.

Which strategy is best for you is a highly personal decision. As Vanguard states,

  • To be comfortable with either strategy, an investor must be fully aware of the fact that historical averages are only a guide it is still possible for LSI or DCA to underperform or even lose money in any given period. If an investor is uncomfortable with the risks associated with a given market entry strategy, it may imply a low willingness to take risk in general, and if so, we recommend revisiting the target asset allocation to ensure that it appropriately addresses risk tolerance levels and investing goals.
  • For an academic analysis of LSI vs. DCA, see Constantides – A Note on the Suboptimality of Dollar-Cost Averaging as an Investment Policy. Finance author Larry Swedroe offers his thoughts on LSI vs. DCA in this article.

Note: LSI vs. DCA refers to a sum you have on hand and are debating on the best way to get it in the market. Investing money as you obtain it, for example investing money from each paycheck, is not an example of DCA.

For low-cost index fund providers, which is preferable, Vanguard, Fidelity or Schwab?

It depends on what funds you want to purchase, what services are important to you, and other factors. Vanguard, Fidelity, and Schwab all have a $0 minimum investment and a solid selection of low-cost index funds (both mutual funds and ETFs) with no commission.

Name ETFs Mutual funds Asset allocation funds Customer service Banking services
Vanguard Any VTSAX, VTIAX, VBTLX and more ($3,000 minimum) Target date funds ($1,000 minimum) and target risk funds ($3,000 minimum) Email and phone support 8am-10pm EST M-F No (some mutual funds allow limited check writing)
Fidelity Any FZROX, FZILX, FXNAX and more ($0 minimum) Target date funds ($0 minimum) Branches, email, live chat, and 24/7 phone support Cash management account with ATM rebates, automatic money market investment, and free checks
Charles Schwab Any SWTSX, SWISX, SWAGX and more ($1 minimum) Target date funds ($1 minimum) Branches, email, live chat, and 24/7 phone support Online checking with ATM rebates, free checks, no FX fees
  • All of the example funds listed are index funds, have a net expense ratio of 0.25% or less, and no commissions
  • Recommended mutual funds are given in the order: US stocks, International stocks, US bonds. For ETF recommendations, see below.
  • The US stock recommendations are all US total stock market funds.
  • The international stock recommendations must be at least as diversified as the MSCI EAFE index.
  • The US bond recommendation are all US bond market index funds.
  • For all ETFs, the minimum investment is 1 share (typically $20 to $200).

The above information may become out of date as time passes, so make sure to check the web site of your chosen investment company for updated fund information.

This answer is based on The brokerage and investment firms frequently recommended on PF which contains more detail and additional brokerage options.

Why does everyone seem to recommend Vanguard?

Given the higher fund minimums, limited hours for customer service, and lack of banking features, it may seem strange that so many people (definitely not everyone!) recommend Vanguard on /r/personalfinance. A lot has been written on this, but the basic arguments that most fans will give are as follows:

  • Vanguard has a unique ownership structure.
  • Vanguard has a broader selection of low-cost index funds (and their actively managed funds are generally very low in cost).
  • The highest fees that an unsavvy investor could end up paying (for funds, advice, or asset management) is significantly lower at Vanguard.
  • Most Vanguard mutual funds are more tax-efficient and suitable for use in taxable accounts while investors generally need to use ETFs to reach the same level of tax-efficiency with other fund companies (this doesn’t matter at all in an IRA or other tax-advantaged account).

In what order should I prioritize my long-term investments?

How should I invest in my 401(k), 403(b), SIMPLE IRA, or other employer-sponsored account with limited choices?

Read our Step-by-Step Guide to 401(k) Fund Selection.

Can you just recommend something extremely specific to get me started?

  • Sure, but you really need to understand what you’re buying. It won’t take you long to study up on index investing and the gains you’ll miss out on by waiting a few days are negligible.
  • It is assumed you have an emergency fund and no expensive debts.
  • The most common recommendations are a target date fund or a three-fund portfolio. Both consist of domestic stocks, international stocks, and bonds.
    • With a target date fund, you just buy a single fund that has a “target date” near your expected retirement age and the complexity of managing the fund allocation is handled by the fund for you.
    • With a three-fund portfolio, you manage your own allocation of the individual funds.
  • If you’re just getting started with investing in an IRA, your best bet is a target date fund at Vanguard, Fidelity, or Schwab:

    Those are all intended to be easy options if you are just getting started and still learning about investing. Target date funds may not be the best options for significantly larger accounts (over $30,000) and taxable brokerage accounts.

    If you’re doing this in a taxable account rather than an IRA, you should consider building a three-fund portfolio instead because target date funds are generally not tax-efficient (this is not a factor in an IRA, 401(k) plan, or other tax-advantaged retirement accounts, of course).

  • Otherwise, you may be best served by a three-fund portfolio which typically consists of the following individual funds:
    • US Total Stock Market Index Fund
      • ETF options include VTI (Vanguard), ITOT (iShares), and SCHB (Schwab)
      • Mutual fund options include: VTSAX (Vanguard), FZROX (Fidelity), and SWTSX (Schwab)
    • Total International Stock Market Index Fund
      • ETF options include VXUS (Vanguard) and IXUS (iShares)
      • Mutual fund options include: VTIAX (Vanguard) and FZILX (Fidelity)
    • Total Bond Market Index Fund
      • ETF options include BND (Vanguard), IUSB (iShares), AGG (iShares), and SCHZ (Schwab)
      • Mutual fund options include: VBTLX (Vanguard), FXNAX (Fidelity), and SWAGX (Schwab)
  • Here are the steps to build a basic three-fund portfolio:
    • Determine your desired bond allocation.
    • Decide how much to allocate to domestic stocks and international stocks. A domestic stock allocation of 60% to 80% is commonly recommended with 20% to 40% allocated to international stocks. The average target date fund allocates about 1/3 of the equity allocation to international stocks (source: Morningstar). For investors outside of the US, it is common to recommend allocating a much smaller percentage to domestic stocks (e.g., 20% to 30%) although costs and other country-specific factors need to be considered.
    • Whenever you add money, instead of adding money in the original proportions, add the money in such a way that after you add money, your portfolio is closer to your desired proportions. If you don’t add money at least once a year, or if you don’t add enough to re-balance as close as you want, log in once a year and sell off the “winners” that are worth more than their proportion, and buy the “losers” that are worth less than their proportion. You don’t have to hit these proportions exactly. Getting within a few percent is fine.
    • For more specific recommendations, consider any of the “lazy portfolios” listed in the Bogleheads wiki.

What bond percentage should I have?

First of all, if you’re using a target date fund, the bond allocation is already managed for you as part of the “glide path” process that gradually adjusts the allocation of a target date fund over time. Therefore, you only need to consider bond allocation for investments that are not target date funds.

It’s not a great idea for anyone to be invested 100% into stocks or 100% into bonds. Historically, stock investments have more volatility than bonds and bonds don’t outpace inflation as well as stocks. For virtually all investors, a mix of both asset classes is a good idea in your investments (after setting up an emergency fund and paying off expensive debts, of course).

Therefore, you need to decide what percentage you want to hold in bonds and what percentage in stocks. This is a complex topic, but some simple approaches are:

  • Subtract your age from 100 or 110, allocate that percentage to stocks, and the remainder is your bond allocation.
  • Subtract your age from 130 or 120, allocate that percentage to stocks (cap at 100), and the remainder is your bond allocation.
  • Use your age in bonds (e.g., a 20-year-old would hold 20% bonds).

While some investors do decide to leave out bonds, most target date funds always include at least 10% bonds even for investors very far from retirement. Holding less in bonds will result in higher volatility so a 100% stock allocation will result in the highest possible volatility.

If you’re uncertain about your bond allocation, take the Vanguard Investor Questionnaire and use the resulting bond allocation recommendation. It tends to produce result a little more on the conservative side, but if you’ve gotten this far without knowing what to do, that’s probably reasonable.

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An Aggressive ETF Bucket Portfolio for Retirement | Morningstar

From

Source: An Aggressive ETF Bucket Portfolio for Retirement | Morningstar

 

Bucket Basics
My aggressive ETF Bucket Portfolio uses the same general framework and assumptions as the aggressive mutual fund portfolio. It assumes a retired investor with a 25-year time horizon (or longer) and a fairly high risk capacity. (Investors can, however, customize their portfolio amounts to suit their own portfolios’ value, as discussed hereThis video does a deep dive into the Bucket approach.)

As with the mutual fund portfolios, I’ve employed three buckets here: Bucket 1, for near-term living expenses; Bucket 2, holding securities with an intermediate-term time horizon in mind, primarily bonds; and Bucket 3, holding the portfolio’s longest-term growth assets.

Bucket 1: Years 1-2
8%: Cash (certificates of deposit, money market accounts and funds, and so on)

As the liquidity sleeve of the portfolio, the focus of Bucket 1 is stability with a modest dose of income. Right now, online savings accounts are likely the best source of guaranteed yield available.

Rather than running with my 8% allocation to cash, retirees interested in the Bucket strategy should be sure to right-size their cash positions based on anticipated spending from their portfolios. A retiree spending just 3% per year of her portfolio, for example, might maintain just a 6% stake in cash (her 3% withdrawal times two years’ worth of living expenses).

Bucket 2: Years 3-10
7%:  Vanguard Short-Term Bond ETF (BSV)
10%:  Vanguard Short-Term Inflation-Protected Securities (VTIP)
13%:  iShares Core Total U.S. Bond Market (IUSB)
5%:  Vanguard Dividend Appreciation Index ETF (VIG)

This portfolio gradually steps out on the risk spectrum, starting with high-quality short-term holdings to serve as next-line reserves should Bucket 1 become depleted and income and rebalancing proceeds are insufficient to refill it. It also holds Vanguard’s short-term TIPS fund to provide a bit of inflation protection. Its core holding is iShares Core Total U.S. Bond Market. The iShares ETF has exposure to the entire credit spectrum, including lower-quality bonds, but its total low-quality exposure is currently less than 10% of assets. At the tail end of Bucket 2 is a position in Vanguard Dividend Appreciation, which is also the main equity holding in Bucket 3.

Bucket 3: Years 11 and Beyond
23%:  Vanguard Dividend Appreciation Index ETF (VIG)
13%:  Vanguard Total Stock Market Index ETF (VTI)
15%:  Vanguard FTSE All-World ex-US ETF (VEU)
3%:  Vanguard High-Yield Corporate (VWEHX)
3%: iShares JPM Morgan USD Emerging Markets Bond (EMB)

Bucket 3 is the growth engine of the portfolio and also has the longest anticipated holding period. Therefore, it features heavy equity exposure as well as smaller stakes in volatile, credit-sensitive bond types.

Vanguard Dividend Appreciation is the portfolio’s largest position. Although its dividend is higher than the broad market’s, at just over 2% it’s not too much higher. But the key attraction here is a focus on quality: The fund focuses on highly profitable firms with histories of raising dividends. That makes it an appropriate anchor holding for investors at any life stage, but its below-average volatility makes it especially appealing for retirees. The portfolio also includes U.S. and foreign-markets index exposure, to bring its costs down and fold in sectors that aren’t well-represented in Vanguard Dividend Appreciation, such as financials and technology.

Whereas the mutual fund portfolios include a stake in  Loomis Sayles Bond (LSBDX) in Bucket 3, the ETF portfolios take a piecemeal approach to riskier bond market sectors, taking small positions in a junk-bond and emerging-markets bond fund. Note that I’ve used an actively managed fund, Vanguard High-Yield Corporate, rather than an ETF for this market segment. That’s because Morningstar’s passive strategies researchers prefer active funds in this space because they can maintain control over liquidity issues and trading costs. The Vanguard fund also cheaper and higher-quality than its passively managed counterparts.

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Retirement Topics – What Happens When an Employee has Elective Deferrals in Excess of the Limits? | Internal Revenue Service

If an employee’s total deferrals are more than the limit for that year, the employee should notify the plan and ask that the difference (called an excess deferral) be paid out of any of the plans that permit these distributions.

Excess withdrawn by April 15. If the employee withdraws the excess deferral by April 15, the withdrawn amount is not reported again as part of the employee’s gross income for the year. Any income earned on the withdrawal is reported as gross income for the tax year in which it is withdrawn. The distribution is not subject to the additional 10% tax on early distributions.

Excess not withdrawn by April 15. If the employee does not take out the excess deferral by April 15, the excess, though taxable in the year of deferral, is not included in the employee’s cost basis in figuring the taxable amount of any eventual benefits or distributions under the plan. In effect, an excess deferral left in the plan is taxed twice, once when contributed and again when distributed. Also, if the entire deferral is allowed to stay in the plan, the plan may not be a qualified plan.

Source: Retirement Topics – What Happens When an Employee has Elective Deferrals in Excess of the Limits? | Internal Revenue Service

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Must-Know Rules for Converting Your 401(k) to a Roth IRA

The Bottom Line

Ideal candidates for rolling employer retirement plans into a new Roth IRA are those who do not anticipate taking distributions from the account for a number of years. Those who convert a 401(k), of either type, into a new Roth IRA must pay a 10% penalty on any money they withdraw from the Roth if they withdraw money within five years from the conversion.

Those aged 59½ or older are exempt from the 10% early withdrawal penalty as are those who transfer the 401(k) funds into an existing Roth IRA that was opened five or more years ago. This exemption allows the rolled-over 401(k) funds to also be withdrawn without penalty.

Source: Must-Know Rules for Converting Your 401(k) to a Roth IRA

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Roth IRA Conversion Calculator | Converting an IRA | Charles Schwab

Why consider a Roth IRA conversion?

Converting to a Roth IRA may ultimately help you save money on income taxes. For instance, if you expect your income level to be lower in a particular year but increase again in later years, you can initiate a Roth conversion to capitalize on the lower income tax year and then let that money grow tax-free in your Roth IRA account. See if a Roth IRA conversion is right for your own financial situation.

Source: Roth IRA Conversion Calculator | Converting an IRA | Charles Schwab

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55e.co – Bucket Strategy

Thank you for your interest in the Bucket Strategy Spreadsheet. The Spreadsheet uses historical data to see how the two or three bucket strategy would have done during different time periods. Historical returns and inflation rates are provided, and custom ones can also be used. Features include: inflated expenses, rebalancing between buckets, and different withdrawal types (Inflation adjusted, fixed, decreasing percentage, and similar to RMD).

I’m starting the price off at $25, and you can send payment through Paypal. Either by my email account (dan@55e.co) or https://paypal.me/55eco Other options could be arranged. What you will get is the Google Spreadsheet, about instructional video on use of the spreadsheet (currently not available) and technical support via email, and possibly video conferencing. Once I receive your payment, I’ll send you the Google Spreadsheet link for you to make a copy to your Google Drive account. The spreadsheet will not work with Excel.

Pay via Paypal and email me at dan@55e.co

Source: 55e.co – Bucket Strategy

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Roth Conversion: Converting IRAs – Fidelity

Converting your traditional IRA to a Roth IRA

Learn about the potential benefits of a Roth IRA and how to take advantage of them if you have assets in a traditional IRA

It’s generally a good idea for most investors to consider including a Roth IRA in their overall retirement planning. Investments in your Roth IRA have the potential to grow tax-free, which may help you save more over time. Plus, Roth IRAs don’t have required minimum distributions during the lifetime of the original owner, and Roth IRA assets may pass to your heirs tax-free.

Determining if a Roth conversion is right for you

Ready to get started?

Roth Conversion Checklists
Follow these simple steps to convert your Traditional IRA or old 401(k) to a Roth IRA.

Anyone can convert their eligible IRA assets to a Roth IRA regardless of income or marital status. Prior to 2010, only those account owners who had a modified adjusted gross income below $100,000 were eligible to convert.

Despite its advantages, Roth may not be the preferred option for all investors. There are three important factors—taxes, time, and costs—that you should consider before you decide if conversion is right for you. Fidelity’s Roth IRA FAQs can help you weigh these factors and get answers to important questions you may have. Be sure to consult with your tax advisor with regard to your personal circumstances.

To learn more about the differences between Roth and traditional IRAs and get a quick overview of eligibility and features, use the Compare Roth and Traditional IRAs.

It’s also important to note that if you are required to take a required minimum distribution (RMD) in the year you convert to a Roth IRA, you must do so before converting.

Considerations for owners of Roth IRAs

Distributions from a Roth IRA are qualified, and thus tax-free and penalty-free, provided that the 5-year aging requirement has been satisfied and at least one of the following conditions has been met:

  • You reach age 59½
  • You pass away
  • You are disabled
  • You make a qualified first-time home purchase

All other distributions are non-qualified. Non-qualified distributions of converted balances are not taxed again (since they were taxed when converted), but they may be subjected to a 10% penalty unless it’s been at least five years since the beginning of the year of your conversion, you’ve reached age 59½, or one of the other exceptions applies.

RMDs are not required during the lifetime of the original owner of a Roth IRA. RMD amounts are not eligible to be converted to a Roth IRA.

If you qualify, you can do an eligible rollover distribution from your old 401(k) directly to a Roth IRA. You’ll owe taxes on the amount of pretax assets you roll over.

Note also, if you have assets in a Designated Roth Account (i.e., Roth 401(k)) and would like to roll these to an IRA, the assets must be rolled into a Roth IRA.

As with Traditional IRA conversions to Roth IRAs, if you are required to take an RMD in the year you roll over into an IRA, you must take it before rolling over your assets.

Learn more about your rollover options

Next steps

Calculator

IRA Contribution CalculatorOpens in a new window Answer a few questions in the IRA Contribution Calculator to find out whether a Roth or traditional IRA might be right for you, based on how much you’re eligible to contribute and how much you might be able to deduct on your taxes.

Roth IRA Conversion ChecklistsGet step-by-step instructions on how to convert to a Roth IRA from a Fidelity or non-Fidelity Traditional IRA or 401(k).

Source: Roth Conversion: Converting IRAs – Fidelity