International Asset Allocation - Importance?

[wabmester]

Smaller cap stocks are more risky, hence they have a risk premium... they should outperform less risky stocks all the time over a reasonable time frame.

using your example on bonds... all people have the same information on bonds, so it does not matter if it is a AAA vs a B, the return will go away over time... well of course this is absurd...

Sorry, I should have specified risk-adjusted returns.    You should get a risk premium for taking risks, but the returns of small/value/emerging have far exceeded any historical risk premium in recent years.    Same applies to the bond market.   The risk premium going forward for junk bonds is almost non-existent, so risky assets have no where to go but down (IMHO).

 

[wabmester]

The tax is paid out of the fund proceeds.  Your taxable amount is grossed up by this tax (maybe someone can check on this)..

I just talked to a rep, and his response was:

1) with the individual funds, they pay the foreign taxes out of the returns, and then you can claim a credit for that tax on your tax returns

2) with the fund of funds, they don't pay the taxes out of the returns, so no credit

He says it's wash, but obviously the taxes get paid somehow in the fund-of-funds case, so maybe the prospectus will make that more clear.

 

[bpp]

I just talked to a rep, and his response was:

1) with the individual funds, they pay the foreign taxes out of the returns, and then you can claim a credit for that tax on your tax returns

2) with the fund of funds, they don't pay the taxes out of the returns, so no credit

He says it's wash, but obviously the taxes get paid somehow in the fund-of-funds case, so maybe the prospectus will make that more clear.

I think in #2 what he means is that the fund-of-funds does not pay taxes explicitly, but the underlying funds do. I have never heard that it is a wash before...

Bpp

 

[wabmester]

I think in #2 what he means is that the fund-of-funds does not pay taxes explicitly, but the underlying funds do.  I have never heard that it is a wash before...

I looked at the prospectus, and it didn't clarify, so I asked the rep if he could document his assertion which is basically that the individual funds report dividends gross of foreign taxes paid, and the fund of funds dividend is net of taxes paid. So, it might not be a perfect "wash" depending on your tax situation, but it should be pretty close.

I'll post an update if I see the mechanics documented.

In any case, my argument is that using the Total International market-cap based allocation strategy makes sense regardless of whether you use Total International as the actual investment vehicle.

 

[Ed_The_Gypsy]

Justin said:

But I rarely see the pundits (the good ones and the bad ones) recommending a 50% international allocation.

Pundits, I dunno, but Less Antman claimed a while back that a 50/50 portfolio of US/international equities had never been down for more than 5 years in a row (he later had to stretch that to maybe 5.5 years). He claimed that he would retire on a 50/50 portfolio of US/International equities [stocks, for him, but promoted the idea to us mutual fund types, too.
http://www.simplyrich.com/board.htm

Paul Merriman also suggests a 50/50 US/int'l equities portfolio. I think he shows here how it would have [past tense ] helped:
http://www.fundadvice.com/articles/retirement/fine-tuning-your-asset-allocation.html

I am roughly 50/50 (international value, emerging markets and a play on China--see below) and it has been very good to me.

I share cool dood's bias against European companies for the same reasons.

Japan has been down so long it looks up to me, but it has been on the upswing for a while (I missed the turn). I am using Matthews Asian Growth and Income to make money on China's growth. [Wouldn't buy a Chinese company, though.] Total portfolio (if I have done my sums right): up 12%/annum over last 5 years, 26% for last 3 years, 30% for last 12 months and 11+% since Jan. Past 5 years, it would take a little work to calculate as the portfolio was fragmented with different providers. Almost all with Vanguard since (including their brokerage for Matthews).

I think I will continue with this breakdown for a while yet.

I am not a total market(s) fan. There are a lot of markets and some make better sense than others. I read Jim Rogers' 'round the world trip reports and make notes.


Ed

Revs 1&2: Fixing fat fingers' foul-ups.
Rev 3: misc updates.

 

[wabmester]

Total portfolio (if I have done my sums right): up 12%/annum over last 5 years, 26% for last 3 years, 30% for last 12 months and 11+% since Jan. 

For comparison, Total International is up 10.32%/yr for 5 years, up 35.9% for the last 12 months, and up 15% YTD. Not bad for a completely passive approach and zero exposure to China.

 

[Ed_The_Gypsy]

wab,

It is a good thing I am not trying to be a professional portfolio manager!

Long ago, I had the predecessor to Total International and didn't think much of it. Didn't like where they were putting the money or something. Now, I like to pretend I have my hand on the throttle. Not quite as ballsy as Uncle Mick's testosterone portfolio, but it works for me.

I will take another look at Total International. Thanks.

Ed, the gypsy in left field.

 

[bpp]

I looked at the prospectus, and it didn't clarify, so I asked the rep if he could document his assertion which is basically that the individual funds report dividends gross of foreign taxes paid, and the fund of funds dividend is net of taxes paid. So, it might not be a perfect "wash" depending on your tax situation, but it should be pretty close.

Maybe I'm being obtuse or picky, but it seems like you are out the foreign tax credit with the fund of funds, making it definitely not a wash, unless this is in an IRA or something like that.

In any case, my argument is that using the Total International market-cap based allocation strategy makes sense regardless of whether you use Total International as the actual investment vehicle.

That I agree with, even if I don't follow it precisely myself. Actually, I hugely overweight Japan for some "home" bias, but the non-Japanese stuff is crudely near market weights, though rounded off to nice round numbers for rebalancing targets. Though I will admit that Europe is rounded down, and EM is rounded up...

Bpp

 

[wabmester]

Maybe I'm being obtuse or picky, but it seems like you are out the foreign tax credit with the fund of funds, making it definitely not a wash

It's a pretty obtuse subject, but here's an example of what I think he is saying.

Let's say that the Pacific Index fund reports dividends of $1100 and foreign taxes paid of $100.

The rep is saying that if you own Pacific Index, your statement would reflect $1100 - $100 = $1000 distributed to you, but you would be taxed on the full $1100 dividend, and then get a tax credit for the $100 in foreign taxes paid.

In the case of Total International, you would only see $1000 dividends, the same amount would appear in your account, and you'd get no tax credit.

 

[bpp]

Ah, now I get it. Ok, yes, if that's how it is done (and it seems to make sense), then it is indeed a wash if your tax bracket is the same as the withholding rate on dividends imposed by the foreign governments.

Bpp

 

[unclemick]

Hmmmm

I fell for all that stuff - in the 70's and 80's - international, gold, silver natural resources, RE, Timberland, etc - this time around I'm with DeGaul and buying American. Perhaps I can dump some of my leftovers this cycle.

Of course - I'm a provincial American in Missouri - if I were ex pat and overseas - I'd be singing a different tune with a different strategy.

Foriegn as in McDonald's Budweisor, Coke, Citigroup, etc
is about as international as I plan to get.

heh heh heh heh - actually at 75% Target Retirement 2015: with their mix - I've bought the story to the extent VG has.

 

[bpp]

Ah, now I get it. Ok, yes, if that's how it is done (and it seems to make sense), then it is indeed a wash if your tax bracket is the same as the withholding rate on dividends imposed by the foreign governments.

Wait a minute, I take that back.

Let's assume 15% domestic and foreign taxes on dividends.

Suppose Pacific Index generates $1000 in dividends, of which $150 gets withheld by foreign governments. You get a distribution of $850, with a taxable dividend of $1000 reported on your 1099, and a $150 foreign tax credit, which is used to cancel out the $150 you owe the IRS on the $1000. End of the day (tax year), you pocket $850.

If you hold Total International Index instead, the fund-of-funds receives $850 from Pacific Index, which it distributes to you. Your 1099 shows a dividend of $850, and no foreign tax credit. You then have to pay 15% of that $850 to the IRS. End of the day, you pocket $722.50.

Still not a wash.

Bpp

 

[wabmester]

Let's assume 15% domestic and foreign taxes on dividends.

Well, I have a slug of Pacific Index, so I took a look at my 1099-DIV.

Foreign taxes paid were about 4.5% of the dividend.

About 71% of the dividend was qualified for the lower rate, so that amount is taxed at 15%.

The other 29% is taxed at your ordinary income rate (generally higher).

And then you subtract the tax credit for the 4.5% foreign tax paid (I don't recall which rate is applied to the credit, but I don't think you get full credit for the taxes paid).

In the case of Total International, the qualified dividends were about 81% of the total dividends, so I'm *guessing* that the foreign taxes went against non-qual'd dividends.

Anyway, the math doesn't appear to be simple, and I don't think Total Int'l is at a huge disadvantage, but buying the individual funds looks like the safer bet.

 

[mb]

This is what I had in mind as well, but do you think the .5% purchase and redemption fee is worth the potential long-term returns?

The purchase and redemption fees are returned to the share holders so if you hold the fund for longer than the weighted average then you should benefit from these fees!

MB

 

[veritasophia]

The purchase and redemption fees are returned to the share holders so if you hold the fund for longer than the weighted average then you should benefit from these fees!

Weighted average? Do you mean longer than the average length of time the fund has been held by all of its investors (weighted on the amount they have in this fund)?

 

[mb]

Veritasophia,

Don't want to think to hard late a might, but I think that dollar weighted average time is the correct metric. If your average dollar is in the fund for a longer time than the average dollar then you should benefit from the fees.

For example the way I interpret it, for example, is if someone invested $10B tomorrow and then pulled it out the next day this would lower the residence time for the average dollar and the other share holders would benefit from the purchase and redemption fees since the fees are "paid to the fund."

I think that I'm interpreting the language on the Vanguard web site correctly? It says something like: "The fees are paid to the fund and therefore it is not considered a load."

Nevertheless I must admit that I hate seeing the purchase fee when ever I invest in it.

MB

 

[Ed_The_Gypsy]

Foriegn as in McDonald's Budweisor, Coke, Citigroup, etc
is about as international as I plan to get.

You ol' redbone--as foreign as Hagen Daz, Nintendo, Tim Horten's and Molson (Coors now, babies!)?

Ed the Gypsy
(once upon a time from the Soviet of Washington and the People's Republic of Oregon)

 

[justin]

I've got a slug of Pacific Index too (probably a much smaller slug than Wab though ).

The dividend that is reported on the 1099 is the actual cash dividend paid out, net of all foreign taxes. There is a section on the 1099 that says how much foreign tax was paid. You get to take all (or almost all, can't remember) of this as a tax credit.

I think the total international fund only receives the cash dividend payout from its constituent funds. The same cash dividend payout that individual shareholders receive. The "foreign tax paid" isn't reported on the 1099, and as a result can't be deducted as a tax credit on your 1040. Can anyone who has a 1099 from the total international fund verify/dispute that?

 

[wabmester]

The dividend that is reported on the 1099 is the actual cash dividend paid out, net of all foreign taxes.

How did you determine that? I determined that it was gross of taxes paid by looking at my statement. The distribution made to my account was exactly equal to the dividend on the 1099 - the foreign taxes paid on the 1099.

 

[justin]

How did you determine that? I determined that it was gross of taxes paid by looking at my statement. The distribution made to my account was exactly equal to the dividend on the 1099 - the foreign taxes paid on the 1099.

I had the $10 account maintenance fee for balances less than $10,000 thrown in there. It screwed my calculations. What you are saying is correct. That is, the 1099 box 1a "Total ordinary dividends" distribution = cash dividend actually received + foreign taxes paid. In my case, it was $110.68 = $105.75 + $4.93.

$110.68 = 1099 box 1a "Total ordinary dividends"
$105.75 = cash dividend actually received
$4.93 = foreign tax paid, as reported on 1099

My hunch is that had I owned the same amount of Pacific index through the total intl fund, my 1099 box 1a "total ordinary dividends" would have been $105.75 and foreign tax paid would have been $0.

In other words, I'd pay tax on a smaller distribution, but I wouldn't get the tax credit for the foreign tax paid.

 

[lazyday]

In my experience, as I recall, the 1099 for foreign funds shows a dividend amount which is the same as my actual dividend received plus the foreign taxes paid. For VG and other funds.
I've read the explanation that this is like your W2 showing income before taxes.

So far, I've always been able to get 100% of the foreign tax credit, but it may depend on your circumstances.

It sure doesn't seem like a wash to me, as bpp demonstrated earlier with example numbers.