Past per­for­mance is not a pre­dic­tor of future performance.

3 factor’s analy­sis com­pares the after tax per­for­mance of a typ­i­cal advi­sor using index funds and a self-managed, sophis­ti­cated investor over the 20-year period from July 1996 through June 2016 to the return a hypo­thet­i­cal 3 factor client would have received over that period. We have made the fol­low­ing assump­tions:

1) Each of the com­pared investors (typ­i­cal advi­sor, self-managed and 3 factor) had an iden­ti­cal asset allo­ca­tion: a glob­ally diver­si­fied, 60% equity, 40% fixed income index fund port­fo­lio, with ini­tially $750k in a tax¬able account and $250k in an IRA. Within equi­ties, 55% is US mar­kets, 30% is inter­na­tional devel­oped mar­kets, 10% is inter­na­tional emerg­ing mar­kets, and 5% is in real estate invest­ment trusts (REITs). When pos­si­ble, US and Devel­oped equi­ties are dis­trib­uted between Large, Large-Value, Small and Small-Value funds. The fixed income allo­ca­tion is divided equally between inter­me­di­ate US and global treasuries.

2) Each year the investor adds $20k to tax­able account and $5k to IRA.

3) Taxes are deducted via shares each April from the tax­able account, assum­ing the high­est tax bracket for a Cal­i­for­nia investor.

4) A typ­i­cal index advi­sor rebal­ances the port­fo­lio quarterly, and performs opti­mal asset location once, when the initial investment is made.

5) Trade transactions fees are deducted. We assume the worse case fee – that all trades are for mutual funds and use Schwab’s maximum fee of $49.95.

6) The self-managed, sophis­ti­cated investor uses an assort­ment of Van­guard funds instead of funds by Dimen­sional Fund Advi­sors (DFA funds are only avail­able to DFA-approved advi­sors) while 3 factor and the typ­i­cal index advisor use both DFA and Van­guard funds. See 3 factor‘s Method­ol­ogy and Invest­ment Risks for com­plete details.

7) The 3 factor man­aged port­fo­lio includes the ben­e­fits of thresh­old-based oppor­tunis­tic re-bal­anc­ing with a tol­er­ance band of 20%, tax advan­taged rebal­anc­ing (spe­cific lot account­ing, whole port­fo­lio re-bal­anc­ing) and tax loss harvesting.

8)  3 factor’s fee is 0.50% up to $3M and then 0.35% thereafter. The fee for other advi­sors is assumed to be as fol­lows: the first $500k is 90 BP; the next $500k is 75 BP; the next $1M is 60 BP; the next $2M is 45 BP; the next $2M is 30 BP; the next $4M is 25 BP; addi­tional assets is 20 BP.

9)  Weekly clos­ing prices and div­i­dend dis­tri­b­u­tions are based on that reported by Yahoo Finance. We used Dimen­sional Fund Advisor‘s 2010 tax data for the break­down of div­i­dend dis­tri­b­u­tions (qual­i­fied ver­sus non-qualified div­i­dend) and pro­por­tion of income tax-free at the state level. We assumed that this data is the same for all funds in sim­i­lar assets classes.

10) Taxes were cal­cu­lated assum­ing the investor is in the high­est tax bracket for a Cal­i­for­nia res­i­dent, and paid each April for the prior year plus an addi­tional tax pay­ment for the final par­tial year.

11) Taxes and adviser fees were paid via reduc­ing shares of secu­ri­ties in the tax­able account; we assume that most investors pay their taxes via other cash sources, so we did not include in our analy­sis any sales trans­ac­tions asso­ci­ated with these payments.

12) For tax loss har­vest­ing prox­ies, we used a vir­tual secu­rity with the exact same per­for­mance char­ac­ter­is­tics as the orig­i­nal secu­rity. Thus we assume that 1) there are appro­pri­ate prox­ies avail­able and 2) that the behav­ior on aver­age over a long time hori­zon of such secu­ri­ties would be very sim­i­lar to the loss secu­rity. If these assump­tions were false, then the advan­tage of tax loss har­vest­ing would be low­ered or elim­i­nated. For this analy­sis, the 3 factor Engine™ was con­fig­ured to only take losses greater than 3% and whose dol­lar value exceeds $5K. Click here to review tax loss har­vest­ing risks.

To calculate the 3 factor advantage we used  mutual fund historical fund data – prices and dividend distributions – from February 1997 to February 2012. We then extended the observed advantages from this period to the full 20-year period.

3 factor’s state­ment that our clients will get the best after-tax returns is not based on our prior per­for­mance his­tory nor is it based on mar­ket sur­veys. Rather it is based on the the­o­ret­i­cal return our clients can rea­son­ably expect if one accepts that the fol­low­ing four assump­tions are true:

1. That investors are best served by sim­ply cap­tur­ing mar­ket returns via pas­sive invest­ing; i.e. that mar­kets are effi­cient and it is very unlikely, over the long haul that an actively man­aged port­fo­lio will out-perform a pas­sively man­aged one

2. That the tech­niques 3 factor employs (tax loss har­vest­ing, tax sen­si­tive rebal­anc­ing whole port­fo­lio, tax lot account­ing, etc.) will likely min­i­mize taxes.

3. If an investor accepts the need to rebal­ance his port­fo­lio (to keep a con­stant level of risk) then sys­tem­atic, whole port­fo­lio oppor­tunis­tic rebal­anc­ing will pro­duce the best results for a rebal­anced portfolio.

4. If besides the above three tech­niques, there are no other meth­ods that can be expected to increase returns, then our claim to be able to deliver the best pos­si­ble after-tax returns stands. Con­versely, if one does not believe in these four assump­tions, then our claim is not valid.

Please click here for the details of 3 factor’s analy­sis and method­ol­ogy.