I WAS A RABID football fan as a kid. I would sweep across our front lawn, fantasizing about the many and varied ways I would run to daylight for Hewlett High School. But when I finally got the chance, I lasted only a few practices. I hadn’t counted on all the bruises that came with the program. So, too, was it with my brief stint as an independent investment advisor affiliated with a large discount broker. After a career as a university professor, and while still working part-time as a psychologist, I realized my lifelong dream of becoming a financial advisor. But once again, I got stopped at the line of scrimmage. I fancied myself a deliberative portfolio manager, not the administrative secretary that the job required. I sought the heady stuff like aligning asset allocations with clients’ needs and risk tolerance, but instead found myself walking them through tortuous retirement-plan application forms. Admittedly, the investment world hardly needed another self-proclaimed portfolio manager to rake off maybe 1% of an investor’s stake, or about 10% of his or her average annual return. I limped off the playing field chastened and wiser about the distinction between dream and reality. But I’m not here just to bemoan my fate. In my brief time as an advisor, it soon became apparent that questions of trust and integrity were far more difficult than those of which way to tilt a portfolio. Often legally bound as fiduciaries to put clients’ interests before their own, financial advisors must wrestle with the moral weight of their recommendations. Consider the ethical dilemma that arose when a 78-year-old widow, whom I’ll call Ivy, gingerly entered my office. She told me she had earned just $27 in annual interest on her $10,000 of savings at her local branch of a national bank. Haltingly and vulnerable, Ivy asked if she might safely get more. She said her and her deceased husband’s state pensions amply covered her living expenses. My client impressed me as frugal. She had no significant debt. She also had a whole-life insurance policy she could tap in an emergency. It soon became evident that Ivy was not investment savvy and that any financial decisions would be made by me. This was a few years ago, when interest rates were infinitesimal but possibly soon heading higher with inflation. I suggested certificates of deposit to increase her return and Series I savings bonds to protect against any rise in inflation. [xyz-ihs snippet="Mobile-Subscribe"] Those recommendations were easy for me. Sure, there were alternatives, but this strategy seemed eminently justifiable. I charged an hourly fee for my services, so my compensation was not affected by selecting two commission-free investments. No need to wrestle with a conflict of interest between what’s best for my client and what’s most beneficial for me. But what if my income was tied to commissions, which CDs and savings bonds do not produce? I was lucky. I had other sources of income, while most advisors don’t. I have attended several advisor conferences and don’t recall even a handful of presentations on CDs and savings bonds. How do advisors who depend on earning commissions defend a practice that repeatedly pits their own financial well-being against their conscience? The mantra is, “We need to be compensated for our time and expertise.” Certainly they do, and they should be. And an hourly fee would accomplish that and do an end run around commissions and the inevitable confrontations with an inherent conflict of interest. I know what you’re thinking, folks. How could this obviously sanctimonious guy level an hourly fee of $175 that might well gobble up much of his client’s first-year interest income? Well, this one was almost pro bono. I charged Ivy for a 15-minute session, and helped her set up her CD and TreasuryDirect accounts, which took far more than 15 minutes. With that attitude, maybe it’s no surprise I didn’t last long as an investment advisor. Don’t get me wrong, I’m no saint. I regularly raise rents on my tenants and I peeked over the shoulder of the girl sitting in front of me during my college econ final. My journey as an investment advisor didn’t go as planned. But I managed to leave with my soul intact. Steve Abramowitz is a psychologist in Sacramento, California. Earlier in his career, Steve was a university professor, including serving as research director for the psychiatry department at the University of California, Davis. He also ran his own investment advisory firm. Check out Steve's earlier articles. [xyz-ihs snippet="Donate"]

If you’ve ever wondered whether Vanguard’s S&P 500 or total stock market fund is the better core holding in your portfolio, you’re probably not alone. Each ETF has over 400 billion in net assets, each has an expense ratio of .03, each has essentially the same dividend (1.25%) and each is categorized by both Vanguard and Morningstar as large blend. Both funds trade at very high volume, making the spread on purchases and sales all but nonexistent. Most telling, The S&P 500 ETF (VOO; VFIAX as mutual fund) and total stock market ETF (VTI; VTSAX) correlate at an almost perfect .99. C’mon man, let’s not waste your time or mine, these guys are effectively identical. In fact, they are very similar, close brothers, but not identical twins. For starters, you may recall that the total market fund is far more diversified (over 3,600 holdings) than the S&P 500. But you may not know that stocks in the market’s preferred benchmark have a median market capitalization of about 250 billion, considerably larger than the 175 billion of the broader market index. VTI is better-diversified and tends to hold smaller companies than VOO. There’s more to munch on, beginning with size. According to Morningstar, midcap stocks comprise just 17% of Vanguard’s S&P 500 ETF and small caps none at all. The corresponding numbers for total stock market are 20% and 8%, leaving less room for larger stocks. Now, let’s dig down to the ETFs’ investment style. The S&P proxy carries a higher percentage of growth names (40% vs. 35%), more technology (32% vs. 30%) and a larger proportion of assets in its top three tech holdings (20% vs. 17%). Vanguard’s total stock market fund’s portfolio is less likely to hold growth companies as well as more likely to own smaller stocks. The S&P not only has a higher percentage of larger stocks. Because of their size, those companies have a disproportionate impact on market capitalization and performance. But performance is where the rubber meets the road. Can these small statistical disparities make a difference in the real world? Over the last ten years, our S&P surrogate had an average annual total return of 13.1%, notably higher than the broader market fund’s 12.5%. Obviously, both funds rode the wave of the market’s last ten years. The S&P 500’s modest edge became substantial with an assist from compounding. A $10,000 lump sum investment over the last decade swelled to $40,100 in the S&P as compared to $37,800 for the total stock fund. Is that $2,300 profit just chump change? It’s not for me and probably not for you either. For sure, some wise guy out there is going to say that’s just random because, in much of the 1970s and 1980s, smaller stocks bested their larger counterparts. The relative superiority of one fund over the other may depend on whether the massive technology companies benefiting from the artificial intelligence mania will continue to boost the more concentrated S&P. Risk is the bane of good performance and we should expect to see the greater success of our S&P proxy to translate into higher volatility. But, alas, this was not the case. It had a smaller loss in turbulent 2022 (-18.1% to -19.5%) and a less severe drop at the extreme (-23.9%) than its all-market counterpart (-24.9%). The Vanguard S&P’s consistency has been nothing short of remarkable. It outgained 90% of its mostly actively managed peers, slipping under the 60th percentile only during the debacle of 2022, when it hovered around fifty-fifty. By comparison, Vanguard’s all-market vehicle underperformed the average large blend fund twice, including at the 25th percentile in 2022. The inability of active management to beat the passively invested Vanguard S&P 500 ETF more than 10% of the time over ten years is reprehensible, but a tale oft told. What do we know and what do we not know? Well, we’ve seen how a small difference in performance between two very similar funds can snowball into a meaningful divergence in profits. We’ve also turned up something anomalous—the better-performing S&P 500 ETF was actually less volatile than Vanguard’s total stock market ETF. What we don’t know begins with the finding itself, which may or may not be repeated. Clearly, the S&P benefited from two tailwinds—the dominance of giant, mostly technology and other growth stocks and the weakness of small caps. None of us know whether the comparative outperformance of the S&P will endure or earn a place in the graveyard of most other market misbehavior. Curiously, to believe that the trend is durable is to lend some credence to momentum thinking. Alternatively, imagining a shift from the higher-performing Vanguard 500 to the lagging Vanguard Total Market has a whiff of rebalancing. VOO and VTI are indeed close brothers, but they are not identical twins. The implications here for retirement are not immediately clear. The different ways the S&P and total stock market fund were constructed should make for a substantial difference in performance, but that is not the case. The modest difference now where the honors go to the S&P can easily be reversed years hence if artificial intelligence turns out to be less than a revolution and smaller companies regain their gusto. Despite lagging some in recent years, Vanguard’s more comprehensive market fund is more diversified by sector and size than its S&P. This feature is unlikely to change since the total stock fund mandates it while the S&P by definition restricts it. For my retirement money, I would prefer the total stock market fund. Even so, unless you have stable and sufficient retirement resources available otherwise, a very large allocation to either fund is probably not advisable nearing or early in retirement. An unlucky sequence of returns will rob you of the assets needed to fully participate in the market’s inevitable recovery and wreak havoc on your withdrawal strategy and emotional well-being. Fortunately, several methods offer protection from this hardship, including high quality short-term bonds. You don’t want to surrender the reward for all those years of hard work and methodical contributions.        

"There’s been a lot of talk about an AI bubble. From our vantage point, we see something very different.” Jensen Huang, CEO Nvidia   “No company is going to be immune (if the AI bubble bursts), including us.” Sundar Pichai, CEO Google (now known as Alphabet)   Is the AI revolution a blessing or a curse, an enduring breakthrough or impending economic and cultural apocalypse? Many investors have taken a position and chosen their weapons, with some wielding funds dedicated to AI and others brandishing funds that minimize  exposure to it. At this juncture, we don’t know if the prices of stocks heavily dependent on artificial intelligence are too high, about right or perhaps even underestimating its power. My aim here is neither to glorify nor vilify readers with large stakes in AI. And it’s certainly not to advocate an oversized role for AI in long-range financial planning for retirement or college  education. Efficient broad market index funds—most now already tilted towards AI—are consensually regarded as the vehicle of choice for those objectives. We are talking here about investing for shorter-term purposes, such as helping to offset a brief encounter with sequence of returns risk. A caveat at the outset. I have elected to use exchange-traded funds (ETFs) rather than index funds for this analysis and discussion. Oh, I know that most AI readers prefer (even demand) passive investing within the tried-and-true mutual fund structure and that Humble Dollar espouses the Boglehead philosophy. But I am also aware the asset flows are fast turning towards the upstart ETF. Since 2011, almost 150 mutual funds have converted to corresponding ETFs and the pace of the desertions is accelerating. In 2024 mutual funds bled over 150 billion in investor money, when ETF assets soared to over 1.1 trillion. While the oft-demonstrated efficiency of the index fund has offered much shelter from this tsunami, it is undeniable that the traditional mutual fund is fast becoming extinct. Though the index fund boasts several of the advantages of the ETF (instant diversification, low cost, transparency and incidental capital gains), it lacks the game-changer. Index funds can only be transacted at the closing price, whereas ETFs can be traded any time during the day just like a stock. To be sure, many skeptics (starting with Bogle) have warned that this ease of trading is actually a double-edged sword. For the impulsive investor or the person who craves action, this feature of the ETF could well foster overtrading or sheer speculation. With that ado, let’s take a close look at two AI-oriented ETFs. The first is a dedicated offering (Global X Artificial Intelligence and Technology: AIQ) and another (Defiance Large Cap Ex-Mag 7: XMAG) whose mandate greatly reduces the influence of AI on its results. Global X Artificial Intelligence and Technology ETF You may be wondering who these Global X characters are and is the outfit legit. The management group is a leading provider of thematic ETFs with over 76 billion in assets spread across 90 stocks. Not surprisingly, three of its top five holdings are members of the vaunted Magnificent 7 (Google now Alphabet, Apple and Tesla). Top ten holdings include other prominent domestic AI stocks (like Advanced Micro Devices) and several likeminded companies from overseas (Taiwan Semiconductor Manufacturing). Let’s be fair now. This Global X ETF is highly volatile. It lost a whopping 36% during the technology bloodbath of 2022, but catapulted an eye-popping 79% over the next two years. What about this year? AIQ is up yet another 34%, a full 10% more than the popular Vanguard Information Technology ETF (VGT). But you have to pay to play--the concentrated AI fund is also very expensive. Its .68 cost will strike many readers as prohibitive if not downright laughable, especially when weighed against the Vanguard offering’s tailored .09. Keep in mind, though, that restricting deployment of the fund to short-term objectives renders the stark cost difference less destructive.  Defiance Large Cap Ex-Mag 7 ETF But what if the enthusiasm and momentum of AI turn out to be overblown? Could the massive indebtedness incurred by AI-dominant companies to fund their capital expenditures prove disastrous to individuals overinvested in them? Enter Defiance, a young ETF provider with a budding reputation for filling overlooked thematic needs in the fund marketplace. The firm has 7 billion in assets, a baby in the fund industry. But it has issued one ETF particularly relevant to this conversation: the Defiance Large Cap Ex-Mag 7 (XMAG). The 98 million fund is designed to give investors the opportunity to own the S&P 500  absent the Magnificent 7, the heavyweights in the AI competition (Google now known as Alphabet, Amazon, Apple, Facebook now known as Meta, Microsoft, Nvidia and Tesla). Because just these seven stocks comprise fully one-third of the S&P, XMAG is far more diversified than Vanguard’s gigantic S&P 500 ETF (VOO). At .35, expenses are modest for a relatively new thematic fund. As an aside, the Defiance ETF and others with a similar goal may help to elude an unlucky sequence of returns during the period spanning late accumulation and early withdrawal of  your retirement assets. With XMAG, retirees have the peace of mind in knowing their nest egg is not unsteadied by the fortunes of  just seven highly correlated AI-infused technology stocks. Two footnotes. I know full well the message of this article runs counter to the spirit of  Humble Dollar, but it is what it is. The discussion is offered for educational purposes only and should not be construed as investment advice. You should consider your own financial situation and risk tolerance and if advisable consult a professional before you invest. In the interest of full disclosure, the author has a 12% position in AIQ and none in XMAG.                        

Sequels are made by film studios trying to capitalize on the success of the original release. Rocky II became another blockbuster for MGM Studios. J.P. Morgan’s Nasdaq Equity Premium Income ETF (JEPQ) is an audience-pleaser right in our own backyard. It’s the glitzy younger sister of the star of the active ETF world, J.P. Morgan’s Equity Premium Income ETF (JEPI). Like most sequels, the new technology-oriented fund borrows a good bit from its predecessor. It’s on a pace to be just as big a moneymaker, attracting almost half of JEPI’s assets in its first two years of operation. The J.P. Morgan version of the Nasdaq 100 fund also contains only slightly fewer stocks than JEPI and costs .35, considered very reasonable for an actively managed fund. As an option-income offering, it trades considerable upside potential for a very high distribution rate. JEPQ’s portfolio managers can sell options on their high-volatility stocks for a higher price than can their counterparts at the more conservative and better-diversified JEPI. This feature allows the tech-heavy ETF to offer a higher yield (recently between 9%-11%) than JEPI (7%-8%), but with a treacherous liability. Like all option-income funds, the two J.P. Morgan ETFs have unlimited downside risk because the sold options provide only partial protection against a steep decline. With its 40% weighting in technology, the more recently issued JEPQ’s downside vulnerability is greater than JEPI’s. How much greater? Let’s take a look. On Tuesday, September 3rd, stocks were clobbered, with the Dow cascading over 600 points. The Nasdaq 100 index itself lost 3.0%, whereas its JEPQ surrogate surrendered 2.0%. This supports the fund sponsor’s assertion that its tech-powered fund is likely to participate in about 70% of losses in the underlying index. Whether readers see that percentage as too dicey or an acceptable degree of exposure will, of course, depend on their investment goals and risk-tolerance. Interestingly, the S&P 500 declined 2.1% on the same day, likewise reinforcing J.P. Morgan’s expectation that the Nasdaq 100 option-income fund is roughly about as volatile as the broad market. It may be that the income from option sales balances out the jumpiness of technology stocks. How did JEPI do this past Tuesday? The darling of the active option-income crowd slumped just 0.6%, once again demonstrating its resilience in the midst of market turmoil. This result only strengthens the case for use of the fund as a high-yielding bond substitute in a balanced portfolio. On that score, it is pertinent to note that both funds pay their dividends monthly, but also that those dividends are not as stable as stock dividends or bond interest. That’s because most of the funds’ payouts derive from the proceeds of option sales rather than the more constant dividends of their individual holdings. In times of market turmoil, traders are willing to pay higher prices for their leveraged option plays These observations invite two inferences. First, retirees who prefer to receive the same income month after month to cover everyday living expenses may not be satisfied with a variable—even if higher—dividend. On the other hand, when JEPI (but not the more racy JEPQ) is deployed alongside a traditional fixed-income fund in a portfolio, fluctuation in its option-generated income may be muted by the steady bond interest. JEPI’s durability makes it a promising candidate to deter a potentially disastrous sequence of returns right before or early in retirement. Why choose concentrated and bouncy JEPQ for the stock sleeve of your diversified portfolio at that critical juncture when it is no safer than the S&P? But might the Nasdaq 100 option-enhanced ETF be helpful as a satellite holding during the accumulation phase? Let’s get a little granular again. In the 2023 recovery from the previous year’s turbulence, the technology-laced Nasdaq 100 index advanced a remarkable 55%. Its option-based proxy rallied a comparatively modest 36%, capturing barely 65% of the gain of the index. The corresponding figure year-to-date through August was a more robust 82%. Notice that, when averaged, the participation rate was just over the 70% expected by the ETF’s issuer. Why limit the upside thrust of the technology sector, when outsized gain is the reason you wanted that overweight in the first place? We saw how JEPI could be a useful adjunct around the time of retirement, but what about in the accumulation phase? Decidedly not. In 2023, J.P. Morgan’s flagship ETF could muster only a disappointing 10% total return as compared to the broad market’s 26%, a paltry 38% of the S&P’s performance. This year has not been any kinder to the fund, which through August rose only 11%, or merely 58% of the year-to-date change in the S&P. We have reaffirmed that JEPI offers an unorthodox way to protect against a harrowing sequence of returns, but that it is woefully inadequate as a total return vehicle earlier in a person’s investment program. Regrettably, the Nasdaq 100 option-income ETF is simply too narrow and too ornery for the stock portion of a retirement portfolio in the distribution phase. The fund is likewise best not cast in a supporting role during accumulation because its short options work as a partial brake on performance. What have we learned about J.P.’s sequel to its better-diversified and fabulously lucrative blue chip JEPI? One could say that because an option-selling strategy smooths out some of the market’s mayhem, it may help keep investors from bailing out from their funds at just the wrong time. But this is a big price to pay for an ETF whose distributions are treated as ordinary income and so is only advisable in more tax-friendly accounts.

The new kid’s back in town and he’s a bully. Remember active mutual funds? Get ready because here come active ETFs. In 2019, there were only about 350 of those guys, but now that number has ballooned to almost 1,500. Remarkably, active ETFs gobbled up over 20% of the net asset flow into stock ETFs in the first half of this year. According to one active ETF advocate, actively management has become more popular as heavyweight asset managers have entered the fray. Fidelity and T. Rowe Price have already thrown their hat in the ring. Even our stalwart friend Vanguard has just launched two active bond ETFs, although as yet the fund group has not offered any purely active stock counterparts. Now here comes the propaganda. How about, “The Investor’s Guide to the Rise in Active ETFs?” Check this one out: “Why Assets Are Flowing into Active ETFs.” What’s the hurry? It’s obvious. The big boys’ enriching high-fee mutual fund is fast becoming extinct and they need to replace it with a slam-dunk alternative.  Hence, the advent of the active ETF, with a cost below the mutual fund fee and only moderately higher than that of the time-tested index fund. What to worry? See, Vanguard already has five stock ETFs classified on its website as active. Launched in 2018, they have languished in obscurity, bypassed by the index fund faithful. I set out to show how the performance of Vanguard’s active stock ETFs—Minimum Volatility, Momentum Factor, Multifactor, Quality Factor and Value Factor—was trounced by that of  index ETFs categorized as comparable by Morningstar, the premier fund advisory service. Folks, that’s not what happened. Quite the reverse, and I’m as dumbfounded as you’re going to be when you peruse the table below. 5-Year Average Active ETF                       Annual Total Return    Risk       TO     Category                                                         Minimum Volatility                                         8%             65          26%       MC Blend  Momentum                                                      14%             83           73%      MC Growth    Multifactor                                                       12%              82          37%      MC  Blend      Quality                                                               13%              77          55%      MC  Blend    Value                                                                  12%              87          24%     MC Value Passive Index ETF   Midcap Growth                                                    10%                            79        14% Midcap Blend                                                        9%                             76        13% Midcap Value                                                        9%                             76         22% Notes: Total return taken from Vanguard. All five active funds are classified by Morningstar as midcap blend, growth or value. Risk refers to Morningstar’s Portfolio Risk Score. The price/earnings ratio from Morningstar averaged 16 for the active ETFs versus 22 for the index ETFs. Turnover (TO) was taken from Morningstar. Takeaway Believe me, I’m as befuddled as you are. The finding that the active ETFs generally performed better than their passive counterparts is, of course, highly counterintuitive. That they did so in the absence of greater risk makes the result even more perplexing. Last, I searched for whether the stark outperformance of Vanguard Momentum might be due to a large technology overweight but, currently at least, this proved not to be the case. Some caveats. Although Vanguard’s “active” ETFs did display higher turnover than their comparable index ETFs, they are not pure active prototypes-- they are factor funds. They do not  depend on a portfolio manager’s judgment and so are probably better denoted as “smart” ETFs. Besides, the active ETFs’ advantage is only marginally actionable since their volume is very low and so their bid/ask spreads prohibitively large. Even then, the study’s outcome is curious, all the more so since the active ETFs’ gains were made in the face of slightly higher average cost (.13 vs. .06). Of course, Vanguard could yet choose to enter the race towards stock ETFs. But if history is any guide, we can anticipate the hoopla surrounding their arrival and the proliferation of active offerings on the ETF landscape to be fleeting.

It’s over. I’m done with it. Done with what? Ruminating about how well I negotiated for the new car? Nope. Leaving the cell phone in that overpriced restaurant? Uh-uh. Then what is it I’m done with? Well, after months of deliberation with Alberta and our son Ryan (and with myself), I’ve decided to hang on to the family’s small residential rental properties rather than sell. Tax considerations trumped quality of life. There, I said it, as preposterous as it may sound. I thought readers might be interested in how I lurched to this decision, so I’ve prepared a review of how the features of owning real estate directly compare with those held indirectly through real estate investment trust mutual funds or ETFs (REITS). Just understand that I’m performing this analysis solely for readers’ benefit, not mine, because all that’s behind me now. It truly is. Who’s at the Helm? When prospective investors weigh the virtues and pitfalls of the active vs. passive approaches they invariably start with the hands-off vs. hands-on decision. Hands-on landlords assume responsibility for management of their rental, which requires much time, energy and expertise. The experienced property owner also recognizes the inevitable assaults on her family’s freedom from periodic interruptions and stress. Active owners enjoy control over their investment. Who could possibly match the dedication and commitment of the self-interested landlord? But direct involvement exposes investors to liability, a nagging source of worry hands-off folks avoid. Such developments may entail numerous consultations with costly lawyers and accountants. People who elect instead to invest in real estate through REIT funds sidestep most of the foregoing trials of landlords. Casting a Wider Net While the pros and cons of adopting a hands-on or hands-off strategy might at first blush be considered a draw, the contest with regard to diversification is a no-brainer. Because of convenience and limited knowledge, most investors in small income properties stay close to home. They are thus vulnerable to the fortunes of the local economy and any climate risks like flooding. Many REITS own over fifty properties spread out across the U.S. Some funds focus on residential real estate and others commercial. Importantly, several REIT funds incorporate international investments in their portfolio. No equivocation here, the diversification offered by REIT mutual funds and ETFs is far superior to the breadth achievable by the small investor. Who’s in Charge Here, Anyway? Management is another realm where the contrast between hands-on vs. hands-off investing is pronounced. The formula for the passive investor could hardly be simpler. You can buy shares in Vanguard’s real estate ETF and pay just .13 for management and associated expenses. In return, you get many of the most experienced and savvy real estate professionals in the country overseeing your investments. The situation for the landlord could hardly be more different. She could, of course, assume all the responsibilities of management including minor fix-ups and repairs by herself. But doing so involves much more than the travails of renting her units and keeping her tenants happy with prompt attention to problems that arise. She’ll be doing a whole bunch of record-keeping and fostering relationships with workers, financial professionals and vendors. If all of this proved too daunting, she could hire a property manager. This obviously takes some of the burden off her shoulders, but it’s no piece of cake either. You’ll want someone whose fee is reasonable (preferably well under 10%) and is cost-conscious as well as reliable. At a minimum, attention to cost begins with his willingness to set aside the urge to just get your repair order off his desk. He often needs to find a second-opinion and not hand the repair person or contractor a blank check. You should also require authorization from him before undertaking expensive maintenance projects. If you just cash your monthly check, bask on the beach in Hawaii and not manage your manager, you’ll fall way short of maximizing your income. The Myth of the Indomitable REIT Dividend A prime attraction of REITS is that they must pay our 90% of their taxable earnings as dividends.  The distribution of the Real Estate index ETF (VNQ) or mutual fund (VGSLX), the consensus standards for REIT investing, is 3.7%. But money markets now yield over 4%, as do many investment grade bond funds and dividend stock funds. By comparison, the S&P’s yield is only 1.3% Even more, unlike those paid by qualified U.S. companies, the dividends from REITS are taxed as ordinary income. The only wise choice then is a tax-advantaged vehicle. You can say you heard it here: If your overriding goal is to maximize income, then feel free to look beyond REIT funds. By contrast, depending on geography and the effectiveness of management, the net income (after expenses) earned by our hands-on counterpart will generally be higher than for the typical REIT or expressly dividend fund. It would not be outrageous to propose an income return approaching 10%. Of course, the effect of a missed dividend from one or two stocks in a diversified fund would be negligible, whereas the loss of several months of rent might necessitate a dip into our landlord’s cash hoard. The verdict here is nuanced. I’ll put it this way. If you’re looking for moderately high steady income, you’ll want the REIT fund. But if you prefer to shoot for that higher but less dependable rental income stream, and are an independent-minded, hands-on type, you should consider owning your own property. Hey, I Gotta Get Out of Here! The next two features we’ll review are related and fall way in favor of passive REIT investing. Say your family is blindsided by a health crisis and you need to raise cash quickly and bail. If you’ve got a duplex on your hands, good luck. Unless you are resigned to give it away, probably weeks if not months will go by before you sell the property. Then chop off an unconscionable selling commission that could be as high as 6%. New regulations make it possible to negotiate a lower amount, but you should anticipate it will still be sizable. What obstacles does the passive investor face? Not many. She can actually sell her REIT ETF shares online in about five minutes and incur no commission (but a tiny spread) regardless of transaction size. This far greater liquidity and zero exit (and entry) costs bestowed on the REIT fund shareholders are stark advantages over private ownership. Over the Holidays Give Thanks to the 1031 “But you don’t get depreciation and you can’t take deductions with your REITS.” That insufferable neighbor Jerry leaned over the poker table and wagged his finger at me. “You threw away cash you could have used as a down payment on that attractive duplex down the street. Jerry was right about the superior tax benefits enjoyed by hands-on owners, but not necessarily for those reasons. Why not? Because the managers of the REITS in your fund are claiming those deductions and taking that depreciation for you. You just don’t get to see it on your tax return. Besides, there is widespread misunderstanding of the depreciation deduction. Yes, your investment is appreciating even as you depreciate it, but hear me out. In a calculation known as recapture, the deduction must be subtracted from your cost basis (at a 25% rate), substantially increasing your capital gain. More accurately, depreciation is an interest-free loan and paid back with cheaper dollars, taking advantage of the time value of money. But it’s not the free lunch it’s often made out to be. So is there any tax advantage to the landlord who has devoted so much time and energy into maintaining his property with an eye toward enhancing its value. There is, but it’s less well-known than depreciating the building and expensing deductions. And it’s only available to sellers who don’t need to use the proceeds for living expenses, home projects or travel. If these owners are instead open to buying a similar kind of property at least as expensive as the one they just sold, they can take advantage of a monstrously favorable provision of the tax code. They can delay realizing the gain until the replacement property is sold. Of course, there’s a hitch or two. The property to be purchased must be identified within 45 days of the sale and the transaction (including the closing) completed in 180 days. Not much time to poke around and deliberate. In fact, I know several people who opted to pay the capital gains tax because they couldn’t find an acceptable investment within the allotted time. The 1031 exchange permits the cost basis of the investment to be stepped up to its value upon the owner’s death. If her heir elects to sell the property within a specified period of time, he will have no or minimal capital gain. Incomprehensibly, the benefits of the 1031 are conferred as well on the heir at his own passing. So it’s not depreciation or the deductions that are the real tax boondoggle, it’s the 1031 exchange. Intergenerational Wealth vs. Quality of Life The humongous tax break provided by the 1031 exchange has compelled our family to tough out the hassles and disruptions of private real estate ownership until Alberta or I (most likely) pass. By so doing, we acknowledge we are surrendering the much greater diversification and ease of selling inherent in investing in small residential income properties through a fund of REITS. We are also reluctantly aware we are inevitably eroding the family’s quality of life during Alberta’s and my senior years. But, remember, I’m completely done with this dilemma. No more obsessing, no more Monday morning quarterbacking. I wrote this for you, not for me. As you can tell, I didn’t need the catharsis. Well, kind of.