IFA established the original IFA Index Portfolios back in 2000, based on the DFA Matrix book and several peer-reviewed academic papers describing what I deem to be "Modern Portfolio Theory." We recently collected several such papers and summarized them with one paragraph and chart in this article. Those original index portfolios have essentially remained the same since 2000.
When we designed these portfolios, we decided to have all Index Portfolios between 90 and 100 be full stock portfolios, with an increasing exposure to small and value stocks, resulting in a numbering system that has caused some confusion for investors.
For example, if you were invested in an Index Portfolio 70, you had 80% of your portfolio in a stock allocation that looked like Index Portfolio 90 and 20% in a bond fund allocation. But now we are going to change the numbering system so it matches the stock allocation and make a slight improvement in the historical efficiency of the portfolios, based on the last 50 years. If you are currently in Index Portfolio 100, there will not be any change.
To convert to the NEW IFA Index Portfolios, we will add 10 to your current portfolio number and change the stock allocation from the current Index Portfolio 90 to 100.
So a current Index Portfolio 60 will change to a New Index Portfolio 70, which will indicate that you have 70% of the asset allocation in the all stock Index Portfolio 100 (instead of 90) and 30% in a bond fund allocation, which will be referred to as Index Portfolio 0. In another example, the current Index Portfolio 75 will be replaced by the New Index Portfolio 85 and will be comprised of 85% Index Portfolio 100 (stocks) and 15% Index Portfolio 0 (bonds). Now that makes a lot more sense! Figures A and B should clarify this even more. The default time period in Figure B is 2013 Year to Date returns. The buttons along the top will provide data for several different time periods.
One of the reasons we did not design the portfolios this way from the beginning was that we thought most investors would not be able to handle the short term return differences between the S&P 500 Index and Index Portfolio 100, even though it was not that far from Index Portfolio 90. However, in our opinion, IFA now has one of the best multimedia investor education programs of any investment firm in the world and in particular, we have unique data, charts, paintings and explanations on the advantages of tilts to small and value equities around the world. Therefore, we believe IFA clients are more likely to disregard this tracking error than other investors. Secondly, we believe that Dimensional Fund Advisors has unique expertise in the index design and trading strategies on global small and value equities and with Index Portfolio 100, we are further benefiting from this expertise. Thirdly, the new dimension of returns based on gross profitability that Dimensional Fund Advisors plans to add to existing funds is expected to have the largest benefit among the small and value equities.
Although the change is a bit confusing, the key benefit is that the New Index Portfolios have been slightly more efficient than the Original Index Portfolios. In other words, at the same risk level of any Original Index Portfolio there was a New Index Portfolio that had a small improvement in return over the last 50 years. This expected return increase in the new portfolios may offset a portion of the advisory fees you pay IFA, even if you choose to stay at the same risk (standard deviation) level. But, past performance is no guarantee of future results.
For example, for clients in the existing Index Portfolio 50 (60% stocks and 40% bonds), IFA's advice is that you move to the New IFA Index Portfolio 60 (60% stocks and 40% bonds), which has had a 0.53% increase in Standard Deviation and a 0.50% increase in historical annualized return based on the last 50.5 years of IFA Index data. Even if you keep the risk about the same by moving to the New Index Portfolio 57, there has been a 0.25% higher annualized return over the same period (see disclosures for backtested performance at www.ifabt.com). If you want to see the data, like so many IFA clients, you can compare Original and New index portfolios in the first section of the IFA Index Calculator at www.ifacalc.com. We also have shown these comparisons in Figure C. You can zoom in on the chart by clicking the Portfolio ranges above the chart.
To view the risk and return data for the New Index Portfolios in a scatterplot over multiple time periods, click the buttons in the bottom left corner of Figure D:
Figure E shows that Index Portfolio 90 had a lower return than Index Portfolio 100 in 22 out of 25 rolling periods shown, despite Index Portfolio 100's 0.91% higher annualized standard deviation over the same period. Only in 3 month, 6 year, and 7 year rolling periods did Index Portfolio 100 have a lower rolling period return. In all other 22 rolling time periods shown, you would have been better off in Index Portfolio 100.
Figure F is the record of how often Index Portfolio 100 outperformed the Original Index Portfolio 90 in various time periods. For example, you can see that in 15-year monthly rolling periods, Index Portfolio 100 outperformed Index Portfolio 90 96.73% of the 428 periods.
To keep this simple, keep trading costs lower and maintain your allocation to stocks and bonds, IFA is advising clients to slightly increase their current risk in their stock allocation by moving the stock allocation from Index Portfolio 90 to 100.
There will be trading costs to make these changes and, in taxable accounts, there may be capital gains taxes as the result of the changes in the equity and REIT allocations. If you have tax loss carry forwards, this may reduce or eliminate the capital gains tax. For an estimate of State and Federal Capital Gains Taxes, see this article from the Tax Foundation.
Despite these costs, the EXPECTED return is higher in the New portfolios and therefore there is an EXPECTED payback period. Your advisor can obtain estimates of your capital gains and estimated payback period. Figure G shows the changes in allocations from a current Index Portfolio 90 to Index Portfolio 100.
If you DO NOT want to accept IFA's fiduciary based advice, you may stay in your existing portfolio number and IFA will continue to rebalance portfolios to the OLD allocations. However, IFA's educational materials, including ifa.com, books and brochures will be transitioned to the New Index Portfolios over the next several months.
As an alternative to our advice, you may want to keep your risk level very close to the same, by moving up about 4 to 7 index portfolios in the New numbering system, depending on your current risk level, instead of the 10 recommended by IFA. However, this will result in an alteration of your current allocation to stocks and bonds. If needed, an IFA advisor can further explain this and provide advice based on your individual situation.
If you are currently in a core, global equity, faith-based or sustainable index portfolio, the only change will be the numbering system. Just add 10 to the Original Index Portfolio number to get to the comparable NEW Index Portfolio.
An email introducing the option to move the New IFA Index Portfolios will be sent to all IFA clients on September 4, 2013 and the IFA.com website will start a transistion to the New portfolios that same day. If you are currently in a standard IFA Index Portfolio and desire to either completely switch or begin a transition process to the new portfolios as soon as possible, please call your advisor directly or you may call IFA at 888-643-3133.
About the Author
Founder and President of Index Fund Advisors, Inc., and author of Index Funds: The 12-Step Recovery Program for Active Investors.