Comments on: Tax Efficiency of Index Funds and ETFs

By: Mike

Mike — Thu, 25 Mar 2010 12:56:15 +0000

Information about past capital gains distributions is widely available for most funds. (There's no guarantee, of course, that future distributions will be close to past distributions, but it can give you some sort of ballpark idea.) For example, if you head to Vanguard's page for their Total Stock Market Index Fund, then click the "distributions" tab, you can see the size of past capital gains distributions. Many people like to set their funds to not automatically reinvest dividends in taxable accounts. This is generally done to make tracking of cost basis easier, but it would also allow for a little cash balance to build up to pay taxes on distributions.

By: Capt. Mike

Capt. Mike — Thu, 25 Mar 2010 12:48:34 +0000

Hi,
If I am investing with a buy and hold strategy in index and etfs in taxable accounts how does a person budget for captial gains taxes realized in the in the funds in the portfolio that may come at the end of the investment year?

How much money can we be talking about with say $100,000.00 in etfs and index funds in a taxable account?

What a nightmare… to invest wisely and at the end of the year have a tax bill you cant pay because your money is tied up in what you invested in.
Kind regards, Capt. Mike

By: Mike

Mike — Thu, 03 Sep 2009 02:05:08 +0000

TIF: I have no firsthand experience of it. I simply read it in Rick Ferri’s The ETF Book (starting on page 64). My general assumption is that if he says it, it’s true.

By: The Investment Fiduciary

The Investment Fiduciary — Wed, 02 Sep 2009 23:10:28 +0000

“The ETF sponsor makes it a point to distribute the shares that have the lowest cost basis, thereby minimizing unrealized capital gains within the ETF’s holdings.”

Mike,

This is good information I am not aware of. Do you have a reference or a source?

Michael

By: Monevator

Monevator — Sat, 22 Aug 2009 09:03:56 +0000

Taxes are my least favourite cost when investing. It seems almost spiteful that after I’ve risked my hard-earned tax income to the vagaries of the market, the taxman can share in my winnings.

The bright side of the bear market – this year I generated a tax loss. Hurrah! (Erm…)

By: Mike

Mike — Fri, 21 Aug 2009 13:52:22 +0000

Hi GoYanks.

Thanks for the kind words about the blog. I hope you continue to enjoy it.

As to dividends: Yes, you’ll pay taxes even if you reinvest them. By the way, I know some people who elect not to reinvest dividends in taxable accounts for recordkeeping purposes. (If you reinvest dividends, you end up with fractions of shares purchased at a multitude of different prices.)

As to the question about historical capital gains distributions, if you head to Vanguard’s funds page, then select any given fund, you can click the “distributions” tab to find some information. The prospectus of each fund will have more information.

By: GoYanks

GoYanks — Fri, 21 Aug 2009 13:44:18 +0000

Mike, Great blog! Have been reading it for a week or so now. This topic brings a few questions that had been in back of my mind for some time now. Its on Taxes on capital gains from mutual funds. I am about to start investing in vanguard index funds in a taxable account after fully funding the retirement accounts – 401K/IRA. When you open an account with Vanguard, it gives you an option for Dividends to Reinvest or take a distribution. If I choose to reinvest my dividends in my taxable accounts, do I still pay taxes? Other part of the question is about capital gains. Since I have not owned any mutual funds outside of my retirement accounts, I have not seen any capital gains distributions. How often they are distributed and where can I find some historic data on capital gains distributions for a vanguard index fund?

By: TheDebtHawk.com

TheDebtHawk.com — Fri, 21 Aug 2009 10:51:57 +0000

Great points Mike. I think that Index funds are the perfect way to invest for the long-term. They force me to practice disciplined personal finance.

By: Mike

Mike — Thu, 20 Aug 2009 19:27:21 +0000

Thanks for bringing that up, Dylan. Very cool.

I remember hearing some talk a while back about whether Vanguard would be licensing other firms to use its ETF-as-a-share-class structure. Seems like a good idea to me…

By: Dylan

Dylan — Thu, 20 Aug 2009 19:19:42 +0000

“The ETF sponsor makes it a point to distribute the shares that have the lowest cost basis, thereby minimizing unrealized capital gains within the ETF’s holdings.”

Interesting, related point: Vanguard’s ETFs are actually a share class of their mutual funds. In theory, particularly as ETFs gain popularity, a fund’s non-ETF shareholders will benefit from this tax management as well.