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July 29, 2006

Tipster set fund scandal snowballing

Filed under: Just for fun — indexfundfan @ 8:28 am

“I think you should investigate mutual funds,” said a clearly nervous female voice.

The anonymous phone message, left with a staff lawyer for New York Attorney General Eliot L. Spitzer, touched off an intense investigation of the mutual fund industry in the summer of 2003. Spitzer, the ambitious prosecutor who had just nailed Wall Street investment banks for sending out biased stock research to investors, was looking for a new target. The $7 trillion mutual fund industry, which had been largely scandal-free for decades, was ripe for exploration, especially given the fees they charge investors for handling their money.

A very interesting read in the Washington Post on how a tipster set the fund scandal snowballing: Tipster set fund scandal snowballing.

July 27, 2006

Making an investment plan

Filed under: Investing — indexfundfan @ 9:01 pm

Before beginning on any long journey, it is important to make a good plan to maximize the chances of success. It is the same with investing – it is prudent to make an appropriate investment plan so that it can guide the investor though the investing journey. This article attempts to address the basic steps to making an investment plan and constructing an appropriate asset allocation.

The above is taken from an article which I wrote in August 2005 about how to make an investment plan in the Singapore context. It had already been posted online elsewhere but to read it there required a registration. Now, you can get the PDF from the link below, no registration required! 🙂

Making an investment plan (PDF, 107kB)

July 26, 2006

Dr Money’s “9 things to ask your financial adviser”

Filed under: Finance — indexfundfan @ 2:34 pm

A reader sent me a link to the following article by Larry Haverkamp in Dr Money (Dr Money is a column in the Electric New Paper in Singapore):,4139,110603,00.html?

In this article, Larry raised some points that probably reflects the state of financial awareness in Singapore. Ask any FA or IFA for advice and if you are not sharp, you could end up being recommended products that are biased on the basis of more commissions to the FA. Here are some of the points in the article:

# 1 MoneySense (MS): Why is this product suitable for me?

Doctor Money’s question (Doc): Does this product help me OR does it merely help the financial adviser meet his product quotas?

Many advisers face a conflict. They quickly exhaust their monthly quota for selling low-margin products like unit trusts and single-premium ILPs (investment-linked products).

After that, in order to earn a living, they need to sell expensive, high-margin products like whole-life, endowment and structured investments.

If this is what they want you to buy, ask about their product quotas.

# 2 MS: What type of product is it? Is it a life insurance policy, unit trust or structured product? Is it for savings, investment or insurance?

Doc: Financial products typically make it difficult to learn their costs.

For insurance, ask how many months of premiums are required for you to pay the distribution costs (commissions)?

How does this compare to charges by the other 10 life insurers?

# 3 MS: What benefit does it offer? Which are guaranteed and which are not?

Doc: Take whole-life and endowment including education policies (WLEE). These popular products look safe.

You will never see a loss on the policy statements your insurance company sends you.

But distribution costs are high and it can take up to 20 years to break even, so you’ll lose money if you redeem before year 20. Isn’t that high risk?

# 6 MS: What are the various fees and charges?

Doc: Unit trusts and ILPs reveal their management fees. But WLEE policies do not. How are policyholders to know if they are being over-charged?

Advanced question: How does the insurer split shared costs – like overheads – between the policyholders’ and the shareholders’ funds? How can a policyholder know if the split is fair?

# 7 MS: Is the financial adviser regulated by the Monetary Authority of Singapore?

Doc: Even regulated advisers have conflicts of interest. Ask yours to rank the products he sells according to commissions earned. Make sure he includes trailer fees. Ask him to reveal his product quotas too.

This article reminds me of the online Singapore-based unit trust forum where, in my opinion, a certain IFA and his protege (to a certain extend), are strong peddlers of certain whole life policies and bashers of term policies (to implement buy-term-invest-the-rest).

Surely, whole life and term policies have their places for different people, but if you have IFAs, who are supposed to act in the client’s interest, expressed the implied opinion that term policies are categorically never recommended for anyone (unless specifically requested by the client himself/herself), something is very wrong. The article by Dr Money certainly sounds a cautionary note for people to keep their eyes open, look past the sweet talk and free gifts, and ask a lot of questions when buying financial products, whether it is from an “IFA” or not.

July 21, 2006

The Triumph of Indexing

Filed under: Investing — indexfundfan @ 7:47 am

The following is a partial reproduction of Taylor’s post (52033):

Each quarter Standard & Poor’s publishes a “Standard & Poor’s Indices Versus Active Funds Scorecard” for domestic stock funds. For the first time Standard and Poor’s has also included comparative figures for international and fixed income funds vs. their benchmark indexes.

Here are five year results (the longest period shown):

67% Large Cap
84% Mid Cap
79% Small Cap

65% Global
80% International
88% Emerging Markets

75% Government Intermediate
84% Government Short
73% General Intermediate
88% General Short
84% High Yield
89% Mortgage-Backed Securities

The report is HERE.

July 20, 2006

Regressive tax brackets under AMT

Filed under: Finance — indexfundfan @ 11:20 am

The alternative minimum tax or AMT has been affecting more and more Americans in recent years. Originally designed as an alternative tax for the very rich who avoided paying tax by claiming various deductions, it is now becoming more and more of a middle and upper-middle class tax. The main reason is because the income thresholds for AMT are not indexed for inflation, quite unlike the regular income tax brackets.

Most people must have heard that the AMT tax brackets are ‘only’ 26% for incomes below $175k or 28% for incomes beyond $175k. This is not quite true. AlvinSch on Diehards forum has raised the issue a few times that AMT brackets are in fact regressive if your income is within the range of $150k and $400.2k (was $382k in 2005, see CNN article: “How the new tax law affects you”, May 17, 2006).

The reason why the effective AMT brackets are not 26% and 28% is because the effect of a phase-out of the personal AMT exemption for incomes above $150k by a quarter of a dollar for every additional dollar earned is ignored. The effect of the phase-out is to increase the tax rate by a quarter of 26% or 28% for incomes in the phase-out range.

Overall, the effective AMT brackets for a couple filing jointly for tax year 2006, taking the phase-out exemption into account, is as follows:

  • below $62.55k : 0%
  • $62.55k to $150k : 26%
  • $150k to $220.04k : 26% + 26%/4 = 32.5%
  • $220.04k to $400.2k : 28% + 28%/4 = 35%
  • beyond $400.2k : 28%

As we can see, the AMT brackets are regressive and actually lower for the very rich with incomes beyond $400.2k.


1) The income of $220.04k is the point at which AMT changes from 26% to 28%. This number, call this Y, occurs when your ordinary income, reduced by personal exemption, is $175k. The calculation to derive Y is as follows:

Y – E = 175000 where E is the personal exemption.

Y is above $150k and E is therefore subjected to the phase-out:

E = 62550 – 0.25(Y-150000)


Y – (62550 – 0.25(Y-150000)) = 175000, giving Y = $220,040.

2) The number of $400.2k is the point at which the personal exemption completely disappears. This number is given by $150k + $62.55k/0.25 = $400.2k.

July 17, 2006

A fool and his money are soon parted

Filed under: Finance — indexfundfan @ 9:52 am

Well, not quite “soon” but over a period of several years.

Shefik Tallmadge was the winner of the $6.7 million jackpot ($335,000 each year for 20 years) in 1988. Imprudent use of the money caused him to filed for bankruptcy last year to save the smaller house he had left. Story here.

July 16, 2006

Foreign bond allocation for Singapore investors

Filed under: Investing — indexfundfan @ 2:50 pm

How does the case for foreign bonds apply to the case of a Singapore investor? Personally, I think the reasons that dictate a small allocation (about 20% or less of bond allocation) to foreign bonds are less convincing for the Singapore investor. This is because,

1) Singapore has a much smaller economy and is significantly more dependent on the global economy compared to the U.S. So, I think it is prudent to have a higher allocation to foreign bonds.

2) Based on historical evidence, the flight-to-safety that benefits treasury securities of the U.S. and other large industrialized nations in a crisis does not proportionally benefit SGS bonds. Therefore, for the flight-to-safety reason, a case might actually be made for an allocation to treasury securities of large industrialized nations.

Furthermore, it is not clear if SGS bonds will actually benefit from the flight-to-safety phenomenon in a severe crisis. For example, a huge terrorist act in Singapore might actually cause SGS bonds to be downgraded. A case in point: according to Larry’s latest book, during the Asian economic crisis, the credit ratings of Malaysia (originally rated AA+) and Thailand (originally rated AAA) were both sharply downgraded. This means that a Thai investor would have found out the hard way that investing in the debt securities of Thailand did not provide the safety anchor desired in the fixed income allocation.

Based on the above, I believe investment-grade foreign bonds should have a higher allocation for the Singapore investor. I think a 50:50 allocation to foreign and Singapore bonds could be an useful starting point for consideration.

The case for foreign bonds

Filed under: Investing — indexfundfan @ 2:43 pm

Investors are often advised to allocate a portion of their portfolio (typically ranging from 20% to 50%) to international equities for diversification. Does this same advise apply to foreign bonds? Below are some of the comments I found. The conclusion might surprise you.

Annette Thau, the author of the highly respected book “The Bond Book”, has the following to say in the second edition of the book. According to her, arguments for foreign bonds might include

1) diversification — this argument has some merits when applied to very large bond portfolios, like those of pension funds of insurance companies. For individuals, if the primary objective is for safe, predictable income, this argument becomes irrelevant.

2) higher total return — while it is true that during certain time periods, foreign bonds have earned higher returns, these periods are only known on hindsight, with good timing and the selection of the correct foreign currency.

3) hedge against the falling dollar — if you can accurately predict the falling dollar, a strong case can be made for international bonds.

Bottom-line — if your bond allocation is used as a portfolio safety anchor, then the case for international bonds is not very convincing. But, if your portfolio is large or if you feel that you have sufficient information to speculate in an informed manner, including international bonds may make sense. But in any case, the allocation should be limited to no more than 10% or 20% of the bond portfolio.

David Swensen, in the book “Unconventional Success” says “foreign bonds offer little of value to U.S. investors”:

1) while foreign exchange exposure may produce the benefit of additional diversification and reduce portfolio risk, investors should however obtain foreign exchange exposure through an asset class expected to produce superior returns, namely foreign equities, instead of using foreign bonds.

2) foreign currency positions, per se, promise a zero expected return, so we can expect similar returns between foreign and U.S. bonds. But, unhedged foreign bonds fails to provide the same protection against financial crisis as US Treasury securities since the impact of foreign exchange in the crisis is unknown.

3) holders of domestic treasury bonds can expect fair treatment from their government since governments normally find no reason to disadvantage their citizens. But, in certain circumstances, foreign governments may realign their interest to the detriment of foreign investors (e.g. exchange controls enacted by Malaysia during the Asian economic crisis, note: example is mine).

Larry Swedroe, in his latest book “The Only Guide to a Winning Bond Strategy You’ll Ever Need”, thinks that the negatives in holding foreign bonds appear to substantially outweigh the positives. However, having said that, Larry also mentions that the only reason for holding foreign bonds will be a potential diversification benefit in terms of interest rate risk:

1) Since interest rates in the U.S. and foreign nations typically do not move in the same fashion, there is a diversification benefit to holding foreign bonds, but this comes at the price of currency risk. This currency risk can be minimized with bond funds that hedge the currency. There is a small cost for hedging.

2) It is therefore OK to invest in foreign bonds if you can get it in a low-cost vehicle and also provided the fund hedges its currency positions and invests in only AA and AAA investment grade bonds.

Rick Ferri believes that the bond allocation should also be diversified like the equity portfolio. In one of his posts, he tabulates a bond allocation as follows

20% in short government / CD ladder (direct investment)
10% in ten-year TIPS (direct investment)
20% in intermediate corporate (LDQ)
20% in high yield corporate (VWEHX)
20% in long corporate (individual preferred stocks)
10% in emerging market bonds (PYEMX)

DFA’s fixed income strategy has a short section on foreign bonds :

Generally, investors pursue global portfolios in order to diversify. Statistically, diversification should result in lower portfolio volatility due to the combination of uncorrelated assets. The use of non-dollar developed market bonds, however, introduces foreign currency exposure. Currency exposure noticeably increases the volatility of the fixed income portfolio, while there is no reliable evidence to suggest that the expected return of exchange rates is anything other than zero. If volatility is increased with the addition of global assets, the whole purpose of international diversification is defeated. Therefore, we believe currency exposure should be hedged in global bond portfolios.

This view is very similar to Larry’s. DFA also provides two very interesting tables.

a) Risk measure of hedged and unhedged foreign bonds


b) Correlations of hedged foreign bond indices

In summary, David Swensen does not think adding foreign bonds is necessary. Annette Thau and Larry Swedroe both believe that there might be some benefit of adding some foreign bonds (e.g. 20% of bond allocation). On the other hand, Rick Ferri thinks that it is a good idea to fully diversify the bond allocation, and that includes adding foreign bonds.

Personally, I think having an allocation to investment-grade foreign bonds is optional, but it may be included at up to 30% of the bond allocation for an U.S. investor.

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