Capital Gains Need to be Focus Before Year End

With the Bush tax cuts on capital gains and dividends due to expire December 31, ETF investors need to evaluate what tax moves to make before the year ends, says the ETF Team at Charles Schwab.

“ETF investors need to focus on capital gains,” Michael Iachini, the managing director of ETF Research at Charles Schwab Investment Advisory during a conference call. Because that tax rate on capital gains may rise next year, “If you have ETFs that you’ve owned for many years, especially since the bottom of market from 2009, you may have big gains. If you have large unrealized capital gains you may want to take them in 2012.”

While ETFs have a reputation for being tax efficient, that efficiency relates to the securities within the fund. Mutual funds incur capital gains every time the fund sells securities for a profit inside the fund. While ETFs can realize capital gains, they rarely do, especially in equity ETFs, because of how the ETF is structured. However, individual investors still incur capital gains in their personal portfolio accounts anytime they sell a mutual fund or ETF for a profit.

Another strategy investors use to lower their capital gains taxes is to sell other investments at a loss. This is called tax-loss harvesting because investors can offset capital gains with a similar loss of capital.  However, a big concern with tax-loss harvesting is investors need to avoid the wash sales rule. If you sell a security for a taxable loss and you buy a substantially identical security to the one you sold within 30 days it’s called a wash sale and you don’t get to count the loss.

“The most important thing clients need to be aware of is that not all ETFs are tax efficient,” said Eric Pollackov, Schwab’s managing director of ETFs.  “There are many ETFs that don’t allow the in-kind redemption process [where shares are traded for other shares] and they have to use cash.” These exchange-traded products track commodities and currencies and often hold futures contracts or physical commodities.”

Pollackov said Schwab has yet to pay capital gains in any of our ETFs since their inception. “This shows the skill of our team,” he said. “We try our best to have each ETF track its underlying index, but also make sure that it isn’t paying capital gains at the end of the year.” Schwab ETFs hold only equities and bonds. None hold commodities, futures or currencies.

Pollackov also noted that Schwab’s original eight ETFs hit a milestone recently by passing their third birthday. This is significant because most investors and advisors refuse to look at a fund before it has a three-year track record. This period of time give investors a good idea how a fund and its manager perform in a variety of markets circumstances. Not only does the third birthday show the products are well established and are probably here to stay, but many rating agencies, such as Morningstar, won’t rate a fund until it’s three years old.

He also suggested investors check out Schwab’s new educational research website at www.schwabetfeducationexchange.com/charlesschwab/

Golden Crossover Index Slices Equity Allocation

Dow Jones Indexes announced on Wednesday that its Dow Jones Golden Crossover U.S. Large-Cap Total Stock Market Index was going to slice its equity allocation from 100% to 25% over the next five days. The remaining 75% of the portfolio would be held in short-term U.S. Treasury Bills, which is pretty close to cash.

Using a quantitative and rules-based algorithm, the index has signaled a downward-trending market condition called a “Dead Cross.” The Dead Cross occurs when the market’s 50-day moving average crosses below its 200-day moving average. In short, a very bad sign for investors.

Known as the “Moving Average Crossover System”, the index’s quantitative strategy dynamically changes component weights between an underlying equity index and a cash index according to the occurrence of “Golden Cross” and “Dead Cross” signals. A Golden Cross occurs when the 50-day moving average crosses above the 200-day moving average. During this period, the index tracks the underlying equity index, in this case the Dow Jones U.S. Large-Cap Total Stock Market Index. During Dead Cross periods, the index is allocated between the underlying equity index and a cash equivalent.

While no ETF tracks the Golden Crossover index, two ETFs track the Dow Jones U.S. Large-Cap Total Stock Market Index: the Schwab U.S. Large Cap ETF (SCHX) and the SPDR Dow Jones Large Cap ETF (ELR).

Dow Jones Indexes says from December 31, 1999 through June 30, 2011, the Golden Crossover index outperformed the Dow Jones U.S. Large-Cap Total Stocks Market Index by 4.44 percentage points and reduced volatility by 5.97 percentage points, measured on an annualized basis.

The Dead Cross occurred in mid August. John Nyaradi says in addition to this, the market entered another rare bear territory indicator on the “point and figure” methodology used by Charles Dow himself. He says a dead cat bounce is a possibility, which is what we appear to be in right now, but that the major trend is negative. He recommends inverse ETFs.

If You Can’t Beat ‘Em, Join Em

If you can’t beat ‘em, join em.

The word Vanguard describes the person or entity at the forefront in any movement, field, or activity. While the Vanguard Group mutual fund company led the charge into index funds for retail investors, it hasn’t been able to take that position in the ETF field.

On Tuesday, Vanguard announced it would sell its entire line-up of ETFs commission-free to its brokerage clients. This comes on the heels of Charles Schwab and iShares offering commission-free ETFs. However, by offering all 46 of its ETFs, Vanguard now offers the largest selection of funds without commissions. Vanguard also lowered the fees to trade stocks and non-Vanguard ETFs to the range of $2 to $7.

Three months ago, iShares offered to sell 25 of its ETFs on a commission-free basis on the Fidelity Investments platform. This came in response to Schwab’s move to offer free ETF trades on its Web site when it launched its first ETFs in November.

Since ETFs trade on stock exchanges, they must be bought through brokers. Hence, investors must pay commissions. These commissions have been one reason standing in the way of investors using ETFs in a dollar-cost averaging investment strategy. Because of this many no-load mutual funds have been able to withstand competition from ETFs. Even with just $10 trades, this comes out to a 10% on a monthly dollar-cost averaging investment of $100. By removing commissions, these firms are taking direct aim at the no-load mutual fund business.

Already, Vanguard posted significant growth in its ETF division. It’s the third-largest ETF company in terms of assets with $108.8 billion at the end of April, more than double the $50.7 billion in the year-ago month. Year-to-date, Vanguard has seen the most net cash inflows in the industry, $11.7 billion, according to Bloomberg.

Vanguard ETF’s offer some of the lowest expense ratios in the ETF industry, with an average of just 0.18%, compared with the industry average of 0.52% according to Lipper. With the addition of commission-free trades, Vanguard could see its growth rate increase even further.

Its top selling ETFs are the $24 billion Vanguard Emerging Markets ETF (VWO), the $15 billion Vanguard Total Stock Market ETF (VTI), and the $7 billion Vanguard Total Bond Market ETF (BND), according to Bloomberg.

For more commentary see:

The Wall Street Journal

Investment News

ETF Trends

Index Universe

Schwab Picks State Street to be Custodian

Charles Schwab appointed State Street to service its newly launched family of eight exchange-traded funds with custody, fund accounting, fund administration and transfer agency services. State Street has provided Schwab with these and and securities-lending services since 2005.

The custodian plays an important part in the creation of ETF shares because its the bank that actually holds the securities in the fund’s portfolio. Each night, the custody bank posts the fund’s actual portfolio and provides the stock to be bought and sold.

State Street, together with the American Stock Exchange, created in 1993 the first ETF, the Standard & Poor’s Depositary Receipts, or SPDRs (SPY). The Boston custody bank manages a family of ETFs under the SPDR name. It provides custody and administration for more than $18.8 trillion in assets and remains the custodian of the SPDR.

Schwab Puts Nail into Mutual Funds’ Coffin

Charles Schwab knocked down one of the last barriers mutual funds held over ETFs, commission free trading, with the launch of its new family of ETFs on Monday.

That’s right. Free!

Previously free was the sole province of the no-load fund, mutual funds that refuse to charge investors a commission to buy or sell their shares. ETFs, because they trade on the stock exchange, require investors to buy and sell shares through a registered stockbroker. And if there’s one thing you can say about stockbrokers, they don’t trade for free. That means every time an investor wants to buy and sell ETF shares, she needs to pay a commission. While discount brokers have reduced the commission to below $20 a trade, this remains a significant fee for small investors following a dollar-cost averaging schedule.

Until now that is.

Open up an account with Schwab and you can trade any of the new Schwab ETFs for free. The catch? Only the new Schwab ETFs trade for free and only when you buy online. Want to buy online an ETF from another company in your Schwab account? That commission starts at at 12.95. Still, it’s a big deal and it will make a big difference for small investors who either day trade or use a dollar-cost averaging strategy.

Dollar-cost averaging is the strategy of investing a steady amount of money into the stock market on a regular basis, such as weekly, monthly or quarterly. The strategy holds two purposes. One, it forces you to save money and invest it on a regular basis. Second, it’s a form or risk management that averages your cost basis. If you had $50,000, and you wanted to put it into the stock market, you could put it all in a variety of investment vehicles in one day. The big risk is that the market falls soon afterward, providing you with an opportunity to have bought even more at a cheaper price. By investing say $1,000 a week, you can average out the year’s volatility and make it work for you.

If the share price falls, because you didn’t put it all in at once, you get an opportunity to buy at a lower price, and get more shares. If the share price rises, you do get less than you would have earlier, but you’re making a profit, your shares are rising.

Realizing investors want to put their feet back into the market, but have lost a taste for niche portfolios; Schwab has created eight conservative, broad-based ETFs to grab the widest audience.

· Schwab U.S. Broad Market ETF (SCHB) – this tracks the Dow Jones U.S. Broad Stock Market Index, a market-cap weighted benchmark that contains the 2,500 largest stocks in the U.S. market. This provides a comparable index for people who want to track the Russell 3000. The expense ratio is 0.08%, which comes in one basis point lower than the Vanguard’s Total Stock Market ETF (VTI) and less than half the 0.21% charged by the iShares Russell 3000 Index (IWV).

· Schwab U.S. Large-Cap ETF (SCHX), which follows the DJ U.S. Large-Cap Total Market Index, a cap-weighted index of the 750 largest U.S. companies. This is Schwab’s alternative to the S&P 500 Index. It also charges 0.08%, compared with 0.09% on the SPDR.

· Schwab U.S. Small-Cap ETF (SCHA). This follows the DJ U.S. SmallCap Total Stock Market Index, the 1750 members of the DJ U.S. Broad Market Index not included in the large-cap index above. This would be analogous to the Russell 2000 small-cap index.

· Schwab International Equity ETF (SCHF). The tracks an index by FTSE, the people who made the benchmark for the British stock market. The FTSE Developed ex-US Index holds about 85% large-cap stocks and 15% small-cap from more than 20 developed markets outside the U.S. It charges an expense ratio of 0.15%.

By the end of the year, Schwab expects to launch four more ETFs to track large-cap growth, large-cap value, international small-cap and emerging markets.

The no-load ETF appears to be part of Schwab’s broader strategy to become the lowest-cost provider in the ETF space. In addition to no commissions, the Schwab ETFs either beat or match the expense ratios of its nearest competitors, making them the lowest priced ETFs on the market.

This follows Schwab’s move in May to lower the expense ratios on all its no-load equity index funds with a minimum investment of $100. At the time Schwab lowered the expense ratio on its Schwab S&P 500 Index Fund to nine basis points, the same charge as the SPDR and half the cost of the Vanguard 500 Index fund, the benchmark for low cost index funds.

Schwab Ready to Enter ETF Market

Mutual fund giant Charles Schwab Investment Management expects to launch its first ETFs during the first week of Novemeber.

A subsidiary of The Charles Schwab Corp., the investment management unit is one of the nation’s largest asset management companies. It held more than $210 billion in assets under management as of September 30. The firm, which says it’s the third-largest provider of retail index funds, manages a total of 82 mutual funds, with 36 actively-managed.