While we don’t rapid-trade in these funds we do rebalance occasionally. I am looking to re-balance before we buy stocks again as part of the annual purchase process (I contribute $500, they contribute $500, and then I “match” $500 for a total of $1500 every year) which happens at the end of the summer. Since many stocks are held in more than 1 portfolio I only describe them one time.

Portfolio One

- Urban Outfitters – low debt, seemingly well run, has recently had departure of top executives. Holding on a bit to see if they can turn things around since drop already priced in. if they don’t turn around by end of summer will drop

- Procter and Gamble – has been a core of the portfolio for a long time with a strong dividend. The CEO recently had a bad conference call and the company hasn’t been growing much when compared to rivals

- Canon – has been a good long term performer but Japan still refuses to have a stock market rally. Need to look at this more but want to have some Japan exposure

- Comcast – held on for a long time when the stock did nothing or tanked because believed in broadband growth and they also added and boosted their dividend over the years. Will watch to see if now it is over valued after the run up

- Ebay – another stock that did nothing for years and went down but finally came back. No dividend but basically a bet on pay pal since they sold Skype. Will look into this some more may want to take profits

- Exelon – the nations’ biggest nuclear utility. Now getting beat because of the low price of natural gas. This hurts coal much more than nuclear because nuclear always runs but it limits its profits, as well. They just took over a big Eastern utility. Will keep holding but watch

- Wal-Mart – recently ensnared in a bribery case. Given their massive size it didn’t move their stock price that much. They have been buying back shares aggressively and boosting the dividend which increases profits per share. On watch

- Philip Morris – had an immediate, great run up. Also a good dividend. May want to see for gains

Portfolio Two

- Also Urban outfitters, Wal-Mart

- Wynn – took almost a 20% hit out of the gate with the share holder dispute issue. Has regained half that loss. Still a great play on China gambling. Will watch

- Siemens – had a big run up but now back to break even. OK run but subject to Euro issues and overseas expropriation and potential corruption issues. Will watch

- Diageo – had big run up and fall, much of which was caused by gyration of UK currency vs. US dollar. Up now at some point may take profits

Portfolio Three

- Also Urban Outfitters, Siemens, Wal-Mart, Wynn

Portfolio Four

- Also Wal-Mart, Exelon

- Nucor – a well run metals company in the US that is subject to vagaries of US economy as well as foreign price competition. Will watch but hate to part with it because it is well run but may not be able to sustain high valuation (see Southwest Airlines)

Portfolio Five

- Also Seimens

- Alcoa is a company like Nucor, well run but hit hard by foreign competition and international prices and demand. Like Nucor would benefit from US rally post “great recession” but that never really materialized. Will continue to watch

- Riverbed – a company with high growth prospects that lost 30% of its value in a single day when they slightly missed their earnings. Held on and since they have hung on at about the same price. Will hold through an earnings release or two seems transient not permanent

This article at Motley Fool asks the question of how such a minor revenue drop drove such a major impact on the stock price.

Clearly the market doesn’t work in very precise ways, but honestly how does a $5M revenue cut in guidance lead to such a dramatic loss of market value? Maybe “fuzzy math” is at work.

Most investors probably saw that Riverbed Technology (RVBD) lost nearly 29% of its market value on Friday. The company reported basically in-line Q112 numbers. Not too bad at this point considering the major product transition going on. Then the wheels started falling off during the conference call. The CFO guided to revenue that at the high end would miss the $202M Q2 estimate by roughly $5M.

Yes, anybody doing the math is probably struggling to understand the stock plunge. It dropped 29% due to a 2% reduction in revenue. All while investors should’ve known that the company was going through a product transition that would muddy up the financials for the 1H of the year.

Since we don’t recommend specific stocks here and everyone should do their own homework I don’t make general recommendations. In the case of my portfolio stocks I watch them and try to assess whether this is a temporary event or a permanent loss of value. It has to be noted that any stock with a high multiple which means that their value is based on looking forward to years of earnings growth is subject to risk when they miss earnings by even a little bit because analysts then tend to “jump off the train”.

In this case after reviewing everything I am going to put the stock on “watch” to see if it comes back next quarter and if the analysts are right or if the stock just hit a minor transition.

The article approaches foreign bonds as a way to achieve a higher yield (interest income) since US interest rates are minuscule.

With the measly yields now offered on presumably safer bonds, like United States Treasuries, savers are seeking more appealing sources of income.  And in the first quarter this year, the average emerging-bond fund tracked by Morningstar returned 7 percent, versus 0.3 percent for the Barclays Capital US Aggregate Bond Index.

The article gets more sophisticated but this is a “classic” case of confusing risk and return.  The return on emerging market debt SHOULD be substantially higher than for less-risky debt, assuming that US debt is actually less risky.

The relative risk of emerging markets compared with developed markets has changed… The average debt level of emerging market countries like Brazil and China is far lower than that of developed ones like the United States and Japan… emerging economies have continued to surge even as much of the developed world keeps struggling with the aftermath of the 2008 financial crisis.

That’s true.  If you ignore the complexities of legal systems and whether or not a country like Brazil or China would default if it was in their best interests to do so, by statistics alone they are superior to the developed world.  Having a modern legal system and being tied to the West didn’t save Greek debt holders from having to take a 75% loss on principal, after all.

The article goes on to describe two key differences – bonds issued in US dollars (“dollar bonds”) and those that invest in bonds denominated in local currencies.  In the previous article on foreign ETF’s I covered Germany, Canada and Australia – those countries would not offer bonds denominated in anything but their local currencies (Euro for now, Canadian dollar, and Australian dollar) but for emerging countries often the debt is denominated in some other currency which makes it more palatable to investors, particularly non-local investors.

If you denominate an emerging market bond in US dollars, then that has the same effect as “hedging” your bond portfolio against fluctuation in the local currency against the dollar, which is a frequent practice for many mutual funds because investors wanted purely the higher yield (and theoretical increase in risk of principal loss that come with this) and didn’t want to also add in the “currency risk” of fluctuations against the US dollar.

Whether the mutual funds invest in “dollar bonds” or bonds denominated in local currency will impact the potential returns of the fund as well as the riskiness of the assets in the fund (likelihood of default).  Per the article many of the funds operate a “mix” of these strategies, which may mitigate some risk (dollar bonds may be issued by more solvent issuers and also don’t have currency risk) but likely leaves some yield “on the table” from local issuers willing to pay a higher rate in local currency as well as the potential gain or loss on fluctuations from the local currency vs. the US dollar.

In the US, corporations mostly go to the public corporate bond market for funding, whereas in emerging countries companies often go to local banks (and Europe is somewhere in the middle).  Since so many companies in the US rely on markets for debt funding, the overall market is (relatively) liquid and large in size, and as a result there are many metrics to track and there is a long history of data to review.  In developing countries, the corporate markets aren’t very deep, and those that do issue debt rather than going to banks often issue it in “dollar” bonds instead of local currencies.  Per the article:

Local-currency corporates exist in Brazil, but the market isn’t very deep… in a less mature market, he might stick with dollar issues.

Compared to the total universe of mutual funds and ETF’s, the portion that is tied to

• emerging market debt
• has bonds denominated in local currencies and / or “dollar” bonds
• has a liquid enough market to make sense

1. Splitting your portfolio between cash / bonds / stocks / real estate
2. Splitting your stock portion between US and foreign stocks
3. Breaking down your stock exposure into industry sectors like technology, finance, consumer products, etc…
4. Adding a category for commodities, generally broken down between the precious metals (particularly gold, which had a huge run up) and everything else (oil, grains, metals, etc….)
5. Reviewing your investments in terms of yield whether it is measured in interest return (bonds, REITS) or dividends (stocks)
6. Categorizing your investments by “tax efficiency”, which favors municipal bonds (which are exempt from Federal and often state taxes) and currently dividends (taxed at a 15% rate) but punishes normal interest which is taxed as ordinary income
7. Splitting your personal portfolio into “retirement” funds which generally are invested without paying taxes, grow (hopefully) over the years with reinvested dividends and interest, but are taxed when you retire and start taking withdrawals, from “non-retirement” funds which are subject to current taxation on dividends and interest but whose “basis” or original investment value have already been taxed.  A third category is Roth investment vehicles which are taxed now but the gain or loss above the current value is not taxed when you take out funds upon retirement

These concepts are all useful ways to review how your money is being allocated across all these sectors of investing.  There is no “one” right way to allocate your portfolio or to even assess how your portfolio is currently deployed.

On the topic of bonds, to me they traditionally represented 1) primarily a vehicle to earn interest, with the rate of interest dependent upon the riskiness of the bond 2) a (relatively) secure means of investing meaning that you expect to get your principal back (i.e. if you invest $50,000 at 2% which unfortunately would be a great rate now you pretty much are focusing on earning $1000 / year in interest and ultimately getting back your $50,000 when the bond matures).

However, the general perception that the bond world is “safe” doesn’t jibe with events that have occurred over the last decade or so.  These events include:

• The massive budget deficits being run by the major world democratic powers in the US and Europe both at the Federal and regional / local levels, which are unsustainable as we found out in Greece and are likely to find out in many other places to come
• The decline of over 30% in the US dollar against other currencies over the last few years, caused by many factors but primarily our low interest rates and a semi-deliberate policy of devaluation
• My personal local exposure to government entities in Illinois at the state and local level (Illinois has the worst state credit rating in the US, and Cook county and the city of Chicago are famously corrupt) which leads me to expect the worst from the municipal bond market

These factors caused me to begin researching foreign bond funds.  My goal was to find foreign bond funds that are

1. From countries with a reasonable prospect of being stable and paid back (i.e. not Greece or countries with no track record)
2. Denominated in a currency that is not US dollar based that is likely to be around in the future (i.e. Canadian or Australian dollar, the Asian currencies, etc…)
3. Put into a fund that doesn‘t HEDGE vs the US dollar – many overseas bond funds hedge against the US dollar so although you get foreign investment exposure in terms of returns and risks, you still are based on the US dollars gains and losses over time.  This is new because until recently most of the funds I can find tended to hedge currency exposure
4. Have a low cost of ownership; preferably as an ETF which doesn’t (generally) incur capital gains and losses on a given year; these changes are “baked” into the share price which fluctuates over time and then you can choose when and how to incur the gain or loss by selling shares rather than being forced to book the gains or losses each year depending on fund activity

I briefly considered buying individual foreign bonds but this required a lot more work and understanding than I was prepared to do.  This may be something I’d consider in the future but since I don’t want to be consumed in research and exposed to unknown IRS forms and risks (since we do our own taxes and direct our own investment) for now I was looking at something less complex.

While it may seem that a lot of individuals are thinking the same things as me (the above thoughts are pretty obvious) sometimes you have to “wait around” for the industry to come to the same conclusions.  I bought the first dividend-focused ETF (DVY) when it came out and was waiting for a while to find it (and I heard about an early cash-back credit card and was an early adopter of this, as well).

PIMCO recently seemed to have what I was looking for when they released three new ETF’s.  The ETF’s are for Australia, Canada and Germany.  Here is a link to the PIMCO web site describing these three investment opportunities.

 PIMCO recently introduced three country index exchange traded funds (ETFs) focused on enabling investors to capitalize on the investment opportunities in Australia, Canada and Germany. PIMCO believes these three countries have balance sheets and debt dynamics that are well positioned in the global economy, considering the potential for slower growth and ongoing deleveraging, and offer important diversification of currency exposures for U.S. investors.

This description from their web site has what I am looking for:

• Countries whose debt load appears sustainable or well managed
• Non US currency exposure THAT IS NOT HEDGED
• In ETF form to limit annual capital gains and losses but allow you as the investor to choose the time for “harvesting” your gains and losses
• A reasonable level of total expenses, which are incredibly important for interest bearing instruments at a time of low interest rates (they are 0.5% for the Australian bond fund, which is still on the high end for me)
• A reasonable level of asset size is desired so that the ETF doesn’t behave erratically or face the possibility of closure (sometimes ETF’s are closed and money is given back to investors).  It helps that PIMCO is huge and if they are likely to move into a sector like foreign bond ETF’s they wouldn’t seem likely to just shut down a fund if it grows more slowly than anticipated
• Australia in particular offers yield (investment return) much higher than US bonds; they currently are above 4% when you’d be lucky to get 2% in US equivalent Federal debt right now.  This of course is factored into the currency level vs. dollar (it is high now) so in some “grand equilibrium” scheme they may or may not be in balance; but in the short to medium term it is fair to say that Australian debt “yields” more than US equivalent debt

In my investing I generally try not to anticipate specific events but rather to have a broader and more diversified spread on investments.  From a currency side, you have the Australian dollar, the Canadian dollar, and the Euro.  The Australian and Canadian dollars have had a huge run-up against the US dollar, which would make someone “chasing return” salivate, and the Euro faces downward pressure for many reasons most notably the PIIGS (Portugal, Italy, Ireland, Greece and Spain) and their expanding financial difficulties and deficits.  However, the game ahead is very long, and anyone that can reliably predict the trend of currencies against the US dollar wouldn’t be writing a blog like this or even commenting on it, they’d be in a giant private jet flying to their giant private island because that is an exceedingly difficult or possibly impossible thing to do.  And even if the Euro goes kaput, a German focused fund would convert into the new German currency, which would be predicted to be among the best currencies of the broken-up Europe.

I will look at these three funds in detail and likely buy ETF’s in them which will 1) be in the bond class 2) hold a reasonable prospect of continued repayment 3) provide non US dollar diversity.

Cross posted at LITGM

The beneficiary has contributed $1500 and the trustee $3000 for a total of $4500. The portfolio has a current value of $4844 for a gain of $344 or 7.7%, which is about 3.7% / year over the life of the portfolio.

The stocks in the portfolio aren’t marked “green” or “red” now meaning that they are up or down (including dividends) more than $200. One stock that has been on “watch” is Alcoa or AA which is a well run US metals company that faces tough global competition and is also dependent on US economy growth in order for it to grow. We will keep monitoring this stock going forward.

The new stocks and other stocks seem to be doing well. We will keep monitoring them all going forward.

Today the portfolio is worth $4925 for a gain of $425, or 9.5% or about 4.5% / year over the life of the portfolio.

When stocks have unrealized or realized gains plus dividends of over $200 I mark them “green”, and when they have unrealized losses minus dividends of over $200 I mark them “red”. Right now there is nothing green or red in this portfolio.

Nucor (NUE) is a well run non unionized steel company with a rising dividend. Unfortunately steel companies are very dependent on the economic recovery and NUE is still below where we bought it. Since it is a well run company with a rising dividend we are holding on to it.

Statoil (STO) and Westpac Banking (WBK) are both foreign ADR’s, one from Norway and one from Australia. They are both denominated in non US currencies so if the US dollar falls they will rise in value. They too are both doing well so far in the limited time we’ve owned them.

This portfolio hasn’t had any “sells” yet (just buys) so taxes are simple, just dividends and a tiny amount of interest income (a few cents). There were no foreign taxes withheld because Australia (Westpac) doesn’t withhold on US dividends, although Statoil (STO) will when they pay out in May 2013.

Update - what is interesting is that the article I linked to below showed Australia withholding at 30%. However, there were no taxes withheld on Westpac (WBK). I started doing some research and it was hard to figure out if their tax treaty with the US meant that there was an exception to the usual 30% withholding, it wasn’t clear, but I assume that my brokerage firm knows what they are doing. Foreign withholding is an area of interest to me so I will try to research it some more as time allows. For now my brokerage firm is not withholding on WBK.

The beneficiary contributed $2500 and the trustee contributed $5000 for a total of $7500. Portfolio 3 is currently worth $7080 for a net loss of ($402) and performance of negative (5.6%), or about negative (1.9%) / year. For a bit there portfolio 3 was into “positive” territory but recently it has slipped slightly under.

Portfolio 3 has one “green” stock which is Wal-Mart, and no current “red” stocks (accumulated loss less dividends over $200). We are watching Urban Outfitters like in Portfolio 2 above and if it doesn’t make a move before September we will sell it when the re-investment period begins.

As far as taxes, there were no sales for gains or losses just dividends of $144. Thus this portfolio has less than $950 in unearned income and doesn’t have to file.

Contributions from the beneficiary total $4000 and from the trustee it is $8000 for a total of $12,000.

The portfolio is now worth $14,142, for a gain of $4,142 or 18%, or about 3 1/2% / year over the life of the portfolio.

All of the portfolios have been helped by the recent run-up in the stock market. Right now a lot of the stocks are marked “green”, meaning that they are up over $200 (unrealized gains plus dividends), and none of the stocks currently held are “red” (meaning they are down over $200 in unrealized losses less dividends).

Wynn Resorts (WYNN), which owns a huge money making casino in Macau off China’s coast, has been in the news a lot because the CEO is feuding with his Japanese partner. It is difficult to tell how this sort of thing will turn off but we are holding on for now because gambling in China is a great place to be. Urban Outfitters (URBN) took a dive when they missed earnings and subsequently the CEO resigned but we held on because they had no debt and seemed to be a candidate for a turnaround… we are watching them for now and if nothing happens we will sell prior to the next buying round at the end of the summer. Our “net” position in Toyota (we bought them twice) is about break-even when dividends are taken into account; it was far down due to the brake scandal and other items but have come back lately at least to even.

For 2011 taxes, this portfolio doesn’t have to file based on “unearned income” (gains plus dividends plus interest income, although now interest income is so damn small it doesn’t matter anymore). There was a gain on Ralcorp that we sold of $295 and dividends of $241 (see “box”) that comes on the 1099 form from the brokerage but unearned gains have to be $950 in order to file in 2011 per the IRS publication 929 which summarizes tax rules for children.

While I am not here to recommend a particular investment strategy I do discuss iBonds and they have a little infographic called “Creating a Safety Net” with iBonds and TIPS and it describes the key features of each. Here is a link to the infographic. They talk about how the bonds move with inflation, interest, maturity, fees, taxes, and price fluctuations.

But on the key measure of “purchase limits”, which has fluctuated over the years from as high as $30,000 per SSN (with the option to also buy equivalent “paper” iBonds which are no longer offered) to as low as $5000, the article says that the limit is now:

Each Social Security number is entitled to a maximum of $5000 a year in electronic bonds.

However – this is incorrect. If you go to the site http://www.treasurydirect.gov, which is now the only place where you can purchase iBonds (you can no longer buy paper ones at banks) – here is what the US Government web site says:

Buying I Bonds through TreasuryDirect:

Sold at face value; you pay $50 for a $50 bond.
Purchased in amounts of $25 or more, to the penny.
$10,000 maximum purchase in one calendar year.
Issued electronically to your designated account.

This price limit changed a few months ago and whomever wrote this article didn’t bother to check this basic fact. That is unfortunate.

In looking at as many of the comments as I could (they are filled mostly with rants and one-sided arguments) no one there knew about this limit either. So Wall Street Journal – could you please fix your infographic? It supports your argument (by allowing for larger purchases) and that little infographic is pretty good other than this key error.

A little background – an ADR is an instrument that trades on a US stock exchange that moves along with the underlying stock on a foreign exchange.  These ADR’s allow you to get stock exposure to overseas markets on an individual stock basis without having to purchase them through an international exchange, which brings additional procedural and processing headaches.  Generally only very large and liquid overseas stocks have US based ADR’s.

For instance Portfolio One, our longest tenured portfolio at over ten years, has the following ADR’s:

- Statoil (STO) – Norway
- CNOOC (CEO) – China
- China Petroleum (SNP) – China
- Taiwan Semiconductor Manufacturing (TSM) – Taiwan
- Toyota (TM) – Japan
- Canon (CAJ) – Japan

The determination of whether or not there is tax with-holding depends on the country.  The rate also depends on the unique circumstances of the country.

This article has a list of countries that do not withhold taxes at all and the rates that they use for US citizens. Below are some of the rates of countries for which my portfolios either have stocks or may consider to have ADR’s in the future –

No Withholding:
Columbia – 0%
India – 0%
Singapore – 0%
South Africa – 0%
UK – 0%

Taxes Withheld for US Citizens:
Australia – 30%
Brazil – 15%
Canada – 15%
China – 10%
Finland – 28%
France – 25%
Germany – 26.4%
Israel – 20%
Italy – 27%
Japan – 10%
Mexico – 10%
Netherlands – 15%
Norway – 25%
South Korea – 27.5%
Spain – 19%
Sweden – 30%
Switzerland – 35%
Taiwan – 20%
Turkey – 15%

As an investor, you can deduct the tax that you pay to foreign countries on your US tax form. This is a tax “credit” so it reduces your tax liability dollar-for-dollar, the best type of deduction. There is a publication called 514 “Foreign tax Credit for individuals” that explains this in more detail. Like everything else related to taxes, ask a professional for advice or read the form yourself. Here is a layman’s summary:

- If you only have passive income (dividends or income) such as is found on a 1099-DIV or 1099-INT
- You claim less than $300 in foreign tax credits (or $600 if married filing jointly)

If the above 2 items occur, then you can just put the amount of foreign taxes paid on your return and you don’t have to file a form 1116 which also ultimately puts limits on the amount of foreign taxes that you can deduct on your US return and is more complicated, as a result.

Thus you may want to select ADR’s from countries with favorable tax treaties with the US and with low withholding of dividends. For instance, China at 10% (and UK at 0%) are better than Switzerland at 35%. This won’t generally matter at the level of dividend income that my portfolios create each year – for instance portfolio 1 had about $500 of dividends in 2011 – so if all of it was (worst case) withheld at 35%, this would be ($500 * .35%) = $175. You need to own a pretty large portfolio to cross $300 in foreign with-holdings… for instance if you had $50,000 in foreign stocks which returned 4% in dividends at 15% foreign withholding that would mean that $50,000 * 4% * 15% = $300.

Note that whether or not the foreign taxes were withheld, you still owe US taxes. Since the recipients of my portfolios aren’t working full-time they have low (or no) income levels and they have low tax rates, anyways. They also benefit (like all investors) from the dividends received rule which limits dividends to 15% tax rates, and their capital gains are also lower because they are in low income brackets.

I hope this is helpful. I always learn something when I take apart the detail of my brokerage statement and try to recalculate everything (now I can recalculate the withheld taxes on dividends!). I recommend that over time you try to do the same, as well. Financial literacy is your friend.

Like every tax rule, there are exceptions and complications, so do your own research.