Watch Out For Taxes On Vanguard Funds Capital Gains Distributions (2019)

Cash Is King…

 

“The depression had driven the over-encumbered rich, like Billy Durant, founder and president of General Motors, into the swelling ranks of the formerly rich.  But for any with cash to invest the opportunities in 1921 were boundless.

Stocks were commandingly cheap. ‘Scores’ of companies were valued in the market at less than their working capital-as if the business itself, apart from the net cash, was worthless.  The shares of ‘large numbers’ of industrial companies were selling at ‘one-third of their intrinsic value.’

Deflation took its toll on real estate as well as on stocks and bonds, to judge by a perusal of the New York Times classified pages… June 26, 1921 edition” (page 194 of James Grant’s The Forgotten Depression).

I used my Newspapers.com subscription and looked up the actual classified section of that day. I came across this:

 

An actual PICTURE advertisement.  Not many actual pictures were shown in the papers back then. In fact, you could go through days, as I have, looking at the various newspapers and not find any pictures.

 

Yet, here we have a desperate homeowner willing to shell out big bucks to get out from under his home.   Interesting, no?

 

Oh but we’re not even close to being done yet. Check this out.

Grant further writes “ On August 24, 1921, the low point of the Dow, many stock prices translated into multiples on 1923 earnings of less than five times.  That held true for the steel companies but also the consumer-products companies that had enjoyed a relatively prosperous depression. Coca-Cola was valued at what would prove 1.7 times 1922 earnings with a dividend yield of 5.26%” (page 197).

 

Now, what’s the point here? 

 

Simple. In a somewhat capitalist economy there will ALWAYS be the business cycle, i.e., ups and downs. There is no getting around this.  Yes, some (seems more and more lately, sadly enough) will argue for government intervention to minimize the business cycle.  

Unfortunately, the more government gets involved the more the business cycle is indeed reduced, but that is only because the downs are permanent. Socialism/Communism always means equality…in poverty, except for the few at the top of course. 

 

But as long as we in the U.S. remain somewhat committed to a capitalistic society the ups of progress are permanent, with some temporary downs thrown in. 

 

The temporary downs are where the real prosperity is made though.  And how you do it is to have cash on the side. No, BONDS ARE NOT CASH EQUIVALENTS!!!

 

Bonds are Not Cash

Vanguard Long-Term Investment Grade Bond Fund(VWESX)

Above is the yearly performance of the Vanguard Long-Term Investment Grade Bond Fund (VWESX).  It is up 21% year-to-date. Sounds good, eh? Again, not cash. It was also down 3 of the last 9 years.  

 

So, if this was one of your cash-like equivalent holdings you proceeded to lose money 33% of the time this decade.  Not cash.

 

TSP G Fund

The TSP G Fund is more like cash in that it always has a positive return.  Similar to a Stable Value fund in your 401k plan, these funds will work just fine as a holding place while you’re waiting for things to tank.  

 

To have access to the TSP G Fund or a Stable Value Fund, though, you need to work in a place where those are an option in your retirement plan. 

 

What if you don’t?  Well Certificates of Deposit or high-yielding savings accounts are your best bet.  Bond funds that are up double digits in this low interest rate environment means they can be down as much too.  Those are not places to hold cash. 

 

Liquidity Needed

Don’t get greedy here.  You want LIQUIDITY in order to pick up stuff on the cheap when the inevitable crash comes.  When that will be is anyone’s guess. But it will come. And those who have cash will be well-positioned to purchase a “Fine Suburban Home” for a bargain due to the “financial conditions of the owner”.  

 

Is that being a parasite? Not in the least.  The owner’s financial conditions were such because he was leveraged too high.  That meant he lived large in previous years, years where you were biding your time, waiting for the inevitable to occur.  He consumed. You deferred. Now you can take advantage. 

 

Look at this house:

This was the first house Charlotte and I owned. We bought it in March, 1998 for around $100,000. I planted those two booming palm trees in in 1998 when they were about a foot tall each. Those suckers have grown beyond my wildest dreams. 

 

Now look at this…

We sold it in 18 months later for $119,000.  The lady who bought it from us sold it a few years later for $160,000.  The value climbed all the way up to the mid-$200s in 2006-2007 when the folks who bought it in 2004 were refinancing to take equity out of the home, as MANY did back then. But in 2011 it changed hands at a foreclosure for $74k. 

 

We had long since moved from Phoenix by then but in 2011 we took a family vacation for Easter back to Arizona.  We showed the kids where we were married. Where Maddy was born. Where we used to live etc. 

 

Upon driving by this house, I saw the front door was wide open. So, I parked the car and figured I’d go take a look and introduce myself as the first owner.   

 

A nice, older man was there putting tile on the kitchen floor.  We got to talking and turns out he was an orthodontist or some kind of high-end dentist.  He essentially bought a block of houses in this neighborhood at foreclosure. He paid less than $80k for each…cash. 

 

A year later, as you can see above, he sold this house for $125k, pocketing a nice profit of $50k, before expenses, obviously 

 

The point though is that he HAD CASH!  He was able to swoop in when everyone else was trying to swoop out and buy quality investments for a song. No one else was able to do that because no one else had cash.  If you had cash you could call the shots. 

 

Now, Redfin feels this house is worth $262k, up $137k over 7 years!

Seems high to me. But, I know nothing about the North Phoenix real estate market. So, maybe this is correct. If so, whoever bought this in 2012 for $125k has more than doubled their money in 7 years. 

 

If my rule of 72 is correct, which it is, that means they’ve averaged a 10% appreciation per year. Not. Too. Shabby.

 

Moral of the story?

 

Cash is KING!!

 

If you’re interested in economic history…and who isn’t! 🙂  Here are some books to read:

 

The Forgotten Depression. 

Monetary History of the United States

A History of Money and Banking in the United States: The Colonial Era to World War II

Economics in One Lesson: The Shortest and Surest Way to Understand Basic Economics 

 

 

 

“““`

Don’t Pay This Tax!

Vanguard just released its preliminary capital gain distribution schedule for its funds.  As expected, in this LONG bull market, many of the actively managed funds will have large capital gains distributions. 

This means more tax for you if you hold these funds in a taxable account.

How You Pay Taxes on Mutual Funds

Mutual Funds hold dozens, even hundreds, of stocks or bonds in their portfolios. Sometimes, throughout the year, the manager will sell a stock or bond for a price higher than what he purchased it for. This results in a capital gain.

That capital gain is paid out the actual shareholders of the fund, typically in December. Those shareholders who receive the capital gain must pay tax on that distribution if the fund is held is held in a taxable account.   (If the fund is held in tax-qualified accounts such as an IRA or 401k you don’t pay tax on the capital gain distribution.)

So, even if you’ve never sold any shares of your fund, even if you are actually DOWN in value on YOUR investment in the fund, you will still have a taxable distribution because of those capital gains 

Let me give you an example. 

You buy fund ABCDE for $100,000 in 2017.  At the year end of 2019, the value has dropped to $98,000.  You are down $2,000. Well that stinks. But that’s the nature of investing in mutual funds, right?

But then, in January 2020, you receive a 1099 showing the fund paid out a Capital Gain distribution of 5% of its assets in December 2019.  This means YOU will have to pay tax on that $5,000 capital gain, even though you are down in the portfolio!

“Wha, wha, what???? How the heck does this happen?” You ask. It’s simple really. If the fund has been around for any period of time, it’s got some serious UNREALIZED CAPITAL GAINS built up in it.  

Unrealized Gains on Capital Opportunity fund

The image above shows the Vanguard Capital Opportunity Fund has nearly $10.5 BILLION of unrealized gains! And that is as of Sept. 2018, wait until the new annual report comes out given the huge market gains in 2019. The amount of unrealized gains will probably grow another 10-15%. 

SOMEONE has to pay tax on those gains when they are realized, i.e., when the fund managers decide to sell a position that has increased in value relative to the price they paid for it.  That someone is YOU, the fund shareholder. And you’ll pay tax on that capital gain regardless if your individual holding is up, down or sideways. 

I can’t even begin to tell you how many times people have complained to me that they have to pay tax on their mutual funds even though they are down on the total balance of their account.  Welcome to the double taxation of Mutual Funds. Fun, isn’t it? 

Of course not.  But being ignorant of the tax treatment of mutual funds doesn’t absolve you of having to pay the tax.  So, best be forewarned

Vanguard Capital Opportunity Fund (VHCAX, VHCOX)

This fund, run by the folks who run the highly-regarded PrimeCap fund, will pay 5.58% of its portfolio as taxable capital gain distributions.  This means for every $10,000 you own you’ll receive a taxable distribution of $558.  

Now, don’t think you’re out of the woods just yet, either. 

Last year this fund had a dividend distribution of .93% of the Net Asset Value.  Thus if you owned $10,000 in the fund you’d have to add another $93 to your taxable distribution as a dividend. 

In fact,  last year your total distributions were more than 12% of the portfolio value:

That means on that $10.000 position you owned in Capital Opportunity you’d receive total taxable distribution of $1,200!

Vanguard Diversified Equity Fund (VDEQX)

This fund-of-funds, in that it invests in other Vanguard actively managed funds, will pay out 6.71% of its assets  by year end. That means for every $10,000 you own, you’ll receive a taxable distribution of $671. And that is just the capital gains alone.  Last year it ALSO paid dividend distributions of around 1.25%. 

Vanguard Health Care Fund (VGHAX, VGHCX)

A perpetual rock star of Vanguard’s funds, run by the good folks at Wellington, this fund will pay out 6.82% of its assets by year end.  Oh, but the good times don’t end there. It also paid 4.15% back in March as a Supplemental distribution to shareholders. Thus, all told, investors will receive over 11% in 2019 as taxable distributions. 

Don’t forget the dividend too.  Last year it paid out $2.18 per share. 

Vanguard Mid-Cap Growth (VMGRX)

Whooooweee!  This fund is going to pay out 11.14% of its assets as taxable capital gain distributions.  That is on top of the nearly 14% it paid out last year. This fund is generating some serious taxable distributions.  Thankfully, it only has a dividend yield of .33%. So the dividend won’t add much to your taxable distributions.

Vanguard Primecap (VPMCX)

Another of Vanguard’s actively managed rock stars.  This fund will pay out just under 6% of its total assets in taxable capital gain distributions. So, for every $10,000 you own, you’ll have to declare $580 as taxable capital gain income 

Add another 1.26% for the dividend and you’re looking at over a 7% taxable distribution.

Scary thing about this fund is that 55% of the portfolio is unrealized gains.  That means unless we hit a serious market skid, this fund will continue to pay heavy distributions for as far as the eye can see.   

Nothing wrong with that of course. Taxes means you made money, right?  Well, not in the wonderful world of mutual funds as I mentioned at the beginning of this blog post. 

Vanguard Selected Value (VASVX)

I’m not familiar with this fund, or its management team.  But familiarity is irrelevant if you own this fund as you’ll still get hit with a 6.06% capital gain distribution. 

Throw in the 1.65% dividend yield and you’re coming up on nearly an 8% total taxable distribution.

Vanguard Windsor (VWNEX)

Another of the stellar line up of Wellington funds, Windsor has been around a LONG time. RIP to its long serving manager John Neff who died this year.

This fund will pay out 8.37% of its asset base as capital gains.  Add in the 2.09% dividend yield, you’ll receive around 10.50% taxable distributions!  YIKES!

Vanguard Windsor II (VWNAX) 

Another of the Vanguard stalwarts, though this actively managed fund is not run by the Wellington team.  Windsor II will pay out 8.17% in capital gains distributions come December. Add to that nearly a 2% dividend yield, and you’re looking at taxable income of $1,000 per every $10,000 you own in this fund. 

Where are the Index Funds?

Notice anything missing from this list?  Yes, indeed, there are no index funds paying out capital gains distributions.  Why is that? Well, apparently Vanguard has a patent to avoid these yearly taxable annoyances.  As if you needed another reason to invest in index funds or Vanguard…

© Copyright 2018 Heritage Wealth Planning