I CAN NOT Believe I Missed This For All These Years…
Randy, from Seattle, emailed this most amazing article, “Vanguard Patented a Way to Avoid Taxes on Mutual Funds”.
For years, I’ve been trying to find out capital gain distributions on Vanguard index funds to compare to their ETFs, as it’s been known for quite some time that ETFs are much more tax efficient than mutual funds.
So, I’d go on a various website, Vanguard, Morningstar, MarketWatch etc expecting to see something like this:
This chart shows the capital gain distributions from the Fidelity SP 500 Fund for 2018. Unfortunately, it combines Short AND Long Term Capital Gains. So, you wouldn’t know if that 37 cent per share distribution is STCG or LTCG unless you researched further.
But whenever I searched the Vanguard S&P 500 Index or the Total Stock Market Index Fund I’d only get this:
This chart shows that ALL of the Vanguard S&P 500 distributions are INCOME, i.e., Dividend Distributions, with NO Capital Gain Distributions.
No matter how many websites I researched I could find NO information on Capital Gain distributions for Vanguard Index Funds. WHY????? This was incredibly frustrating to me.
I’ve been an advocate of Vanguard for decades. Primarily because low-cost, tax-favorable investments are the way to go to boost returns. Without question.
But when asked by countless investors does it make sense to invest in Vanguard ETFs or Vanguard Mutual Funds, I recommended ETFs because of the inherent tax benefits. However, I couldn’t prove Vanguard Mutual Funds did NOT also carry those same tax benefits.
And thus the article from Bloomberg cited above is so meaningful..
Vanguard literally has patented a way to avoid taxes on mutual funds! And they own this patent until 2023. Apparently, other firms have had the ability to do this too but simply neglected to, USAA for one, Again why?
If you have the ability to increase your investors returns by delaying, if not outright eliminating the capital gains taxes they pay, why would you NOT do that? It’s not nefarious, not in the least. In fact, I’d argue you have a FIDUCIARY responsibility to understand the tax code to the best of your knowledge to help your investors enhance returns. Heck, Warren Buffet does this all the time!
How many times have I had an investor receive a 1099 tax distribution in a fund they own all the while that fund was down for the year… the investor, rightly so, was mystified.
“You’re telling me I have to pay tax on a $40k capital gain for a fund that is down 20% for the year?”
“Yup. It’s the nature of how mutual funds are taxed. George W. Bush tried to change this but it went nowhere in Congress.”
Fast forward 15 years later and here we still are. Except now Bloomberg is trying to make it seem Vanguard is engaging in some scheme to rob the IRS of “their” money.
Heck no! It’s Vanguard’s commitment to its investors, i.e., the OWNERS of the firm that once again proves why they are head and shoulders above the competition. They saw a way for their shareholders to avoid, or at least delay, unnecessary taxes while investing in their firm and they took advantage of that.
Why other firms didn’t do the same is actually the point of contention, if you ask me. USAA, you had the option to do the same but neglected to follow through? Why?
In 2018, if you owned the USAA S&P 500 Index Fund in taxable account you would have received a capital gain distribution of 40 cents per share. Thus, 1000 shares would have netted you a $400 tax capital gain. How much was short vs. long term? I don’t know. I didn’t feel like researching it. Because the absurdity of this entire tax structure proves my point.
But it’s even worse. Look at that capital gain distribution in 2012. A dollar and a penny a share! That was a distribution rate of 5% of the entire fund. Thus if you owned $100k you received $5000 in taxable capital gains.
What did that $5k do to your bottom line when it comes to Social Security taxation, Medicare Premiums, etc?
What did Vanguard pay out? NOTHING!
Who is a better steward of investor assets? I think the answer is obvious.
And this is not just a hit on USAA. It’s ALL firms! They all have this ability to do the same. But they don’t. Again, why??? Because they don’t need to. There is not a huge clamour among their investors for more tax-efficient investing. So, no fuss? No bother.
Similar to index funds, no? No one had an index fund other than Vanguard until the writing was on the wall and the clamour so loud that the other firms had to roll them out in order to compete. Again, Vanguard lead the way. The others…just followed, kicking and screaming.
“But Josh.,” I can hear the naysayers. “You aren’t avoiding taxes with Vanguard funds, you’re just deferring them.”
Really? If I have 100k in a Vanguard S&P 500 Index fund with a $50k cost basis, what happens from a tax perspective when I die?
My kids inherit that fund…with NO TAX DUE! That means the entirety of that $50k unrealized gain was completely tax free to my heirs.
Secondly, when I have deferred capital gains, I get to make the decision as to when to pay the tax. Not the mutual fund company. I can sell, I can hold, I can do whatever I want, according to MY tax planning. All the other fund companies though decide for me when to pay some tax.
Wrong answer! Proper tax planning requires being in control of your taxable distributions. As such, with Vanguard’s understanding of the tax code, there really is no reason to choose anyone else for your investments.