3 factor imple­ments the fol­low­ing advanced invest­ment man­age­ment techniques:

Opti­mal asset location

By plac­ing more tax-efficient assets in tax­able accounts, and less tax-efficient assets in non-taxable accounts (e.g. IRAs), the 3 factor Engine™ can reduce your taxes.

Whole port­fo­lio, tax-sensitive rebalancing

Over time, a port­fo­lio will drift away from your tar­get asset allo­ca­tion. To main­tain your asset allo­ca­tion and risk pro­file, you need to rebal­ance the port­fo­lio peri­od­i­cally, com­monly once per year, although some investors do it more fre­quently. The 3 factor Engine™ imple­ments whole port­fo­lio, tax-sensitive rebal­anc­ing main­tains your proper asset allo­ca­tion while min­i­miz­ing taxes.

Tax loss harvesting

Tax loss har­vest­ing involves sell­ing assets that have declined in value in order to accu­mu­late tax losses which min­i­mize taxes. To main­tain con­stant mar­ket expo­sure after sell­ing the asset, the 3 factor Engine™ buys a sim­i­lar (but not iden­ti­cal) ‘proxy’ asset for 31 days after which, if desired, one buys back the orig­i­nal asset. Tax loss har­vest­ing is not mar­ket tim­ing (read more). Click here to review tax loss har­vest­ing risks.

Thresh­old rebalancing

Many investors peri­od­i­cally rebal­ance, say either quar­terly or annu­ally. Thresh­old based rebal­anc­ing, which the 3 factor Engine imple­ments, is done when assets drift out­side of a pre­scribed tar­get and tol­er­ance band. For exam­ple, if the tar­get of an asset is 10% with a tol­er­ance 20%, no rebal­anc­ing would be called for unless the asset is below 8% or above 12%.

Oppor­tunis­tic rebalancing

While triv­ial thresh­old rebal­anc­ing sells or buys assets to return to its tar­get per­cent­age, oppor­tunis­tic rebal­anc­ing, which the 3 factor Engine™ imple­ments, moves an asset class that’s out-of-band to the mid-point of the band. For exam­ple, if an asset class that should be at 10% is at 7%, addi­tional shares of the asset would be bought to adjust its over­all per­cent­age to 9%, half way between the tar­get (10%) and the low band (8%).

Enhanced index funds

Enhanced index funds, such as those from Dimen­sional Fund Advi­sors (DFA), are cus­tom designed to seek improved returns. Inde­pen­dent research as well as our own analy­sis indi­cate that they can pro­vide higher returns.

 

Quan­ti­fy­ing expected returns

To quan­tify the addi­tional expected returns from these tech­niques, we sim­u­lated three investors, each using the same asset allocation:

A sophis­ti­cated, self man­aged investor

She uses pri­mar­ily Van­guard funds, rebal­ances her port­fo­lio quar­terly, and ‘opti­mally locates’ her assets, plac­ing her high tax­able income pro­duc­ing assets, where pos­si­ble, in her IRA.
Account man­aged by com­pe­tent advisor

She pri­mar­ily employs funds from DFA (Dimen­sional Fund Advi­sors) and Van­guard, rebal­ances quar­terly and charges an indus­try stan­dard fee (0.9% on the first $500k, etc). Like the self-managed investor, she does ‘opti­mal asset location’.

Account man­aged by 3 factor

Like the com­pe­tent advi­sor, the 3 factor man­aged account uti­lizes funds from DFA and Van­guard. How­ever, instead of sim­ple quar­terly rebal­anc­ing, this account is man­aged via the 3 factor Engine™, which employs thresh­old based, oppor­tunis­tic rebal­anc­ing, con­tin­u­ous opti­mal asset loca­tion, spe­cific tax lot account­ing, and tax loss har­vest­ing. The 3 factor Engine™ sys­tem­at­i­cally looks for invest­ment advan­tages across your whole portfolio.

Thanks to the advanced tech­niques employed in the 3 factor man­aged accounts, over 15 years, the study demon­strates that the 3 factor client ended up with a much larger port­fo­lio. Although we went to great lengths to make this study real­is­tic, of course we used past returns, since no one can pre­dict future returns. But we believe the study shows that the 3 factor Engine™ is likely to lead to higher per­for­mance. See our method­ol­ogy for details and assumptions.

 

 

Based on this analy­sis the 3 factor client would have ended up with $771k more after 15 years. Very few advi­sors, let alone indi­vid­ual investors uti­lize the tech­niques we’ve mentioned.