The Cliff Notes Version of the New Proposed Tax Code

The Cliff Notes Version of the New Proposed Tax Code

While many of us will defer holiday shopping until after Thanksgiving, it’s never too early to start making your list and checking it twice.  Got your eye on a certain something?  Add it to the list. Think of a great gift idea for a relative? Add it to the list. The Trump Administration has been doing the same.  A couple of weeks ago, the Administration and Republican leadership jointly released their tax reform wish list, the Unified Framework for Fixing Our Broken Tax Code.

Given the complexity of the proposal and the breadth of possible impact, we believe a cliff notes version is in order.   

1. Reduction in the number of tax brackets

Think of tax brackets like steps on a ladder. All income is not taxed at the same rate, rather, it gets to ride through each bracket and is taxed along the way. The amount of income that falls in each bracket depends on your filing status (i.e., single or married). The current proposal would reduce the number of tax brackets from seven (10%, 15%, 25%, 28%, 33%, 35%, 39.6%) to three (12%, 25% and 35%) and leaves the door open to a fourth top rate to ensure wealthy taxpayers don’t pay a lesser share of income tax than paid today.

2. Elimination of exemptions with increase in the standard deduction

Exemptions are like gifts from the IRS, allowing most taxpayers to avoid tax on a small amount of income each year. Deductions are essentially approved expenses that the IRS allows you to subtract from income. Taxpayers may elect to take the greater of the minimum, standard deduction or itemized deductions. In 2017, as long as you file a return, you will get an exemption for you and your dependents of up to $4,050 per person. For example, if you are married with two children, your exemption amount would be $16,200 ($4,050 x 4).  The 2017 standard deduction amount is $6,350 for single filers and $12,700 for married joint filers. The current proposal would eliminate the use of personal exemptions but roughly double the standard deduction amounts to $12,000 for single filers and $24,000 for joint filers.

3. Elimination of state and local tax deduction

In 2017, taxpayers who itemize deductions may deduct state income, sales, real estate or property taxes from the amount of income subject to federal income tax. The tax proposal would disallow this deduction from income.   

4. Increase in the Child Tax Credit and phase-out limits

Currently, parents can get a tax credit of up to $1,000 per child under the age of 17, provided certain qualifications are met, but the amount may be reduced or eliminated if income is above a certain threshold ($75,000 for single filers and $110,000 for joint filers). The tax plan proposes an increase to both the credit amount and the income level at which the credit starts to phase-out, meaning that higher-income families could get more benefit from the credit. 

5. Repeal of the estate tax

Currently, an individual may transfer up to $5,490,000 of wealth during his or her lifetime, or at death, without incurring a transfer tax. If approved, the tax proposal would eliminate tax on transfers, regardless of the size of an individual’s estate at death.

Related: Why You Need to Carefully Consider Your Retirement Plan Investments Now

6. Elimination of the alternative minimum tax (AMT)

Simply put, AMT is an alternative way to calculate tax liability.  If this second equation results in a larger liability, then you will pay more.  The proposal calls for an elimination of this second calculation.    

There are also a handful of proposals directed at small business and corporate tax, including the reduction of the top corporate tax rate from 35% to 20% and the top rate on small businesses and family-owned businesses (conducted as sole proprietorships, partnerships and S corporations) to 25%.  Much will be debated in the coming weeks as the proposal makes its way through Congress. The process is a bit like making sausage – how it starts and how it looks in the end may be very different.  So, as with all legislative reform, we must wait and see. 

Making $ense of Economics Indicators

A data point that can be used to predict the future of or the current position of the economy. Leading indicators such as stock prices and housing starts are used to predict the future direction of the economy. Lagging indicators, such as unemployment and inflation, tend to change after an event, making them useful for confirming where the economy is. For example, unemployment typically doesn’t rise until after the economy weakens so rising unemployment can confirm that the economy has, in fact, weakened.

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Multi-Factor or Not Multi-Factor? That Is the Question

Multi-Factor or Not Multi-Factor? That Is the Question

Written by: Chris Shuba, Helios Quantitative Research, LLC

Let’s pretend you are a US investor that wants to deploy some of your money overseas.  You think international developed market stocks are attractive relative to US stocks, and you also think the US dollar will decline over the period you intend to hold your investment.  Your investment decision is logical to you. But you have choices:  You could a) simply invest in a traditional index like the MSCI EAFE, b) invest in a fund that systematically emphasizes a single factor (like a value fund) that only buys specific stocks related to that factor, or c) invest in a developed fund that blends several factors together, like the JPMorgan Diversified Return International Equity ETF (JPIN).  What is the best choice? 

Investing in a traditional international market capitalization index like the MSCI EAFE is not a bad choice. It has delivered nice returns for a US investor, especially uncorrelated outperformance in the 1970s and 1980s, and helped to diversify a US-only portfolio.

Your second choice is to invest in one particular factor because it makes sense to you.  Sticking with the example of a value strategy, you might believe a fund or index that chooses the cheapest or most attractively valued stocks based on metrics like Price to Earnings (PE) is best.  

You could go find a discretionary portfolio manager who only buys stocks he deems to be cheap.  Typically the concept of “cheap” is based on some absolute metric that the manager has in mind, such as never buying a stock with a PE greater than 15.  If there are not enough stocks that are attractive, he will hold his money in cash until he finds the prudent bargains he seeks.  This prudence also obviously risks possible underperformance from being absent from the market.

The alternative is to buy a value index or fund that systematically only buys the cheapest stocks in a particular investment universe.  So if there are 1000 investable stocks available, the index ONLY buys the cheapest decile of 100 stocks and is always fully invested in the 100 securities that are relatively cheapest.  This is an investment approach that a discretionary manger may disdain.  The discretionary value manager may look at those same 100 stocks and think they are pricey.  But nevertheless, academic research has shown that always being fully invested in the relatively cheapest percentiles of stocks in the US has produced superior returns over many decades. 

Such a portfolio is called a “factor” portfolio.  Why the name?   In the early 1960s, academics introduced the concept of beta and demonstrated that individual US stocks had sensitivities to, and were driven by, movements in the broad market.  In the early 1990s, academic research began to show that other “factors” such as value and size also drove US stock returns.  Since then, several factors have been identified as driving individual stock outperformance: value, size, volatility, momentum and quality.  Stocks that are cheaper, smaller, less volatile, have more positive annual returns and higher profitability have historically outperformed their peers.  It turns out these factors also work internationally.

Related: Who Gets Sick When the U.S. Sneezes?

Of all the factors, value is the factor that has been the best known the longest (even before it was academically identified as a “factor”), thanks to the books of Warren Buffet’s teacher Ben Graham.   And if you look abroad at an array of developed global markets and create a value index and compare it to its simple market capitalization weighted brother, the historic outperformance of value has been stunning.  Until recently.  

While there was some variability by country, on average from the mid-1970s up until 2005 a value factor portfolio in a developed market outperformed its market cap weighted index by about 2% a year.  That’s a lot. By contrast, since 2005, the average developed country value portfolio has underperformed a market cap indexes by about -40 basis points.  Which is the danger of investing in one factor.  It may not always work at every point in time.

So if investing in one factor like value runs the risk of underperforming, how about a multi-factor international developed equity portfolio?

Below is a breakdown of individual factor portfolios’ performance in international developed equity markets since 2005, an equal weighted factor portfolio as well the performance of the MSCI EAFE as our performance reference.  Note that, for the last 13 years, value has been the poorest factor by far, while the others have handily beaten the EAFE.  An equal weighted portfolio of all 5 factors, while not as optimal as some of the individual factor results, beats the EAFE by 1.6% and has an information ratio, or risk adjusted returns that are superior by 37%.  The equal weighted factor portfolio also has the advantage of not having to predict which factor will work when, so even when a factor like value does not beat the market, the other factors can pick up the slack.

SOURCE: MSCI, Data as of January 31, 2018. Past performance is no guarantee of future results. Shown for illustrative purposes only.

The equal weighted factor portfolio has one other advantage over the market cap weighted alternative. Note in the chart below how well the portfolio outperformed in the 2008 crisis, so it tends to do relatively well in highly volatile sell offs.

SOURCE: MSCI, Data as of January 31, 2018. Past performance is no guarantee of future results. Shown for illustrative purposes only.

While it’s not inconceivable that one or two of these factors could erode, or underperform for a stretch, the fact that you have exposure to multiple factors in a portfolio that seems to do especially well in crises suggest the multi-factor blended portfolio remains the most attractive way to invest in developed markets.

So, when asked the question: Multi-factor or not multi-factor?  The data speaks for itself.

Learn more about alternative beta and our ETF capabilities here.

DEFINITIONS: Price to earnings (P/E) ratio:  The price-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings.

DISCLOSURES: MSCI EAFE Investable Market Index (IMI): The MSCI EAFE Investable Market Index (IMI), is an equity index which captures large, mid and small cap representation across Developed Markets countries* around the world, excluding the US and Canada. The index is based on the MSCI Global Investable Market Indexes (GIMI) Methodology—a comprehensive and consistent approach to index construction that allows for meaningful global views and cross regional comparisons across all market capitalization size, sector and style segments and combinations. This methodology aims to provide exhaustive coverage of the relevant investment opportunity set with a strong emphasis on index liquidity, investability and replicability. The index is reviewed quarterly—in February, May, August and November—with the objective of reflecting change in the underlying equity markets in a timely manner, while limiting undue index turnover. During the May and November semi-annual index reviews, the index is rebalanced and the large, mid and small capitalization cutoff points are recalculated.

Investors should carefully consider the investment objectives and risks as well as charges and expenses of the ETF before investing. The summary and full  prospectuses contain this and other information about the ETF. Read the prospectus carefully before investing. Call 1-844-4JPM-ETF or visit to obtain a prospectus.
J.P. Morgan Asset Management
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