VANGUARD: It's A Myth That Index Funds Can Become 'Tax Traps' During A Bear Market

It's A Myth That Index Funds Can Become Tax Traps During A Bear Market (Vanguard)

It is often claimed that index mutual funds - funds that are created to replicate of an index - can become a tax trap during bear markets when fund managers are forced to sell their holdings and distribute profits in the form of capital gains. But Scott Donaldson of Vanguard's Investment Strategy Group dismisses the argument as a myth.

"Typically, an index fund in practice carries a wide dispersion of share lots in each security - that is, groups of shares purchased at different prices, both high and low - that serve as a powerful defense against the risk that such portfolios will become 'tax traps'."

"...It's important to understand that a broad-market index fund has the ability to sell share lots that were purchased at high prices and realize losses that can then be used to offset gains elsewhere in the portfolio," Donaldson said. "Thus, a well-managed index fund can use its high-cost share lots (those purchased at high prices) to accommodate redemption requests. As a result, redemptions during a bear market can actually help a broad-market index fund remain tax-efficient."

HOWARD MARKS: Heed This Omen, The Risks Of 2007 Are Back (Oaktree Capital)

Oak Tree Capital's Howard Marks thinks "we're seeing another upswing in risky behavior." This he says was "spurred by central bank policies that depressed the return on safe investments." Marks says he sees the same characteristics now that he saw in 2007 before the financial crisis, though not to the same degree. These risks include 1. Global glut of liquidity. 2. Very little interest in traditional investments and investors are moving towards alternative investments. 3. Little concern about taking on risk. 4. Meager prospective returns.

"In short, it's my belief that when investors take on added risks - whether because of increased optimism or because they're coerced to do so (as now) - they often forget to apply the caution they should," Marks writes. "That's bad for them. But if we're not cognizant of the implications, it can also be bad for the rest of us."

Advisors Should Tell Their Clients About Donor Advised Funds (The Wall Street Journal)

Charitable giving is something affluent clients often care about yet advisors pay very little attention to donor advised funds (DAFs), writes Mark R. Mersman, financial advisor at Michigan-based USA Financial in a new WSJ column. Clients can set up a DAF and the put money into it and take a tax write off for the amount they have donated. They then tell the fund where to donate the money.

But that isn't the only benefit of the DAF. "Instead of collecting tax receipts from multiple organizations, clients can collect one tax receipt for the DAF and still contribute to multiple charities," writes Mersman. "Also, clients can let the fund sit and grow indefinitely, meaning they don't need to grant funds to charities immediately if they aren't ready." But advisors should also warn their clients about the costs associated with DAFs and point out that they give up control once the donation is made.

Stocks Are Outyielding Bonds Everywhere (BlackRock)

Investors chasing yield have been in a tight spot as government bonds and money market funds have delivered negative returns after accounting for inflation, according to BlackRock. But yields on international stocks are higher than those of government bonds.

Investors that stuck with the 60% stock and 40% bond portfolio model saw returns of 10% a year from 1990-2011, according to Elizabeth MacBride at CNBC. But that strategy might have lost its usefulness. Burt Malkiel, CIO of Wealthfront told CNBC that bond investors will be badly hurt.

"The correct allocation ought to depend on individual circumstances. It is definitely not the right kind of thing for everybody. What I had in my "Random Walk" for the last several editions is a quite different allocation. You should have more equity orientation. Another rule of thumb: Jack Bogle has often said bonds should be a percentage equal to your age. I don't agree with that, either.

"I think that allocation is particularly wrong today because we are in an age of financial repression. ... Europe and Japan are having trouble reining in budget deficits, and we have high debt in the U.S., too. (The governments) are deliberately keeping interest rates down. Even a U.S. bond index fund is not the right thing to do, because BND [Vanguard Total Bond Market ETF] is about two-thirds government or agency bonds."