Exchanging One Vanguard Fund For Another

[Kelty]

Hello.
I am considering exchanging all of my VTINX (about $10,500) for VBIAX.
What is the cost of such an exchange?
What are the tax implications of such an exchange?
How do I decide if it is wise or foolish to make such an exchange?
How do I decide the timing of making such an exchange?

[damjam]

Hello.
I am considering exchanging all of my VTINX (about $10,500) for VBIAX.
What is the cost of such an exchange?
What are the tax implications of such an exchange?
How do I decide if it is wise or foolish to make such an exchange?
How do I decide the timing of making such an exchange?

VTINX is Vanguard Target Retirement Income Fund
VBIAX is Vanguard Balanced Index Fund Admiral Shares
If you hold the fund directly with Vanguard there is not charge for moving from one fund to another.
The tax implications depend on what type of account the fund is held in. Is this in an IRA, or a plain old taxable account?

What is the thinking behind your wanting to switch?

[Kelty]

Is this in an IRA, or a plain old taxable account?
It's just a plain old taxable account. With VTINX I have had no long-term capital gains. Would I have long-term capital gains with VBIAX during the first year?

What is the thinking behind your wanting to switch?
I am considering the switch in order to attain a better asset allocation. However, if exchanging is not wise, I could get a better asset allocation by keeping the VTINX and adding something like VTSAX. However, I am more interested in VBIAX than I am in VTSAX.

[damjam]

Is this in an IRA, or a plain old taxable account?
It's just a plain old taxable account. With VTINX I have had no capital gains. Would I have long terms capital gains with VBIAX during the first year?

What is the thinking behind your wanting to switch?
I am considering the switch in order to attain a better asset allocation. However, if exchanging is not wise, I could get a better asset allocation by keeping the VTINX and adding something like VTSAX.

If you have no capital gains there should be no tax consequences to selling VTINX and buying whatever you want. You will pay tax on any dividends you have received.
In order to have long term capital gains you need to hold the fund for at least a year. During the first year any gains would be short term gains.

If you have no capital gains and therefore no tax consequences to selling, I see no reason why you should not switch funds to achieve the proper AA. I assume you purchased this fund recently? I guess I'm a little surprised you have no gains, do you have a loss? (I'm assuming you know how to calculate whether you have a gain or loss. Speak up if your not sure.)

Edit: I think you may have updated you post to indicate you have no long term capital gains. Not that you have no gains.

If you have short term gains then you need to decide if paying the tax is worth it to you. Keep in mind short term gains are taxed at your regular marginal tax rate not the preferential rate for long term gains.

[Kelty]

If you have no capital gains there should be no tax consequences to selling VTINX and buying whatever you want. You will pay tax on any dividends you have received.
In order to have long term capital gains you need to hold the fund for at least a year. During the first year any gains would be short term gains.

From what you say, I must have got short-term and long-term capital gains backward. VTINX did have short-term capital gains. So my question is this: If I switched to VBIAX, would the time period for short-term capital gains start all over again?

If you have no capital gains and therefore no tax consequences to selling, I see no reason why you should not switch funds to achieve the proper AA. I assume you purchased this fund recently? I guess I'm a little surprised you have no gains, do you have a loss? (I'm assuming you know how to calculate whether you have a gain or loss. Speak up if your not sure.)

I purchased VTINX nearly a year ago, and it has earned something over $500 so far. The short-term capital gains are pretty inconsequential--only $18.

Something I'm confused about is the timing. Because the market is up, this is a good time to sell VTINX but a bad time to buy VBIAX. Would the exchange be a financial wash? Or would it be better to wait until the market goes down a bit to make the exchange?

[damjam]

I purchased VTINX nearly a year ago, and it has earned something over $500 so far. The short-term capital gains are pretty inconsequential--only $18.

Something I'm confused about is the timing. Because the market is up, this is a good time to sell VTINX but a bad time to buy VBIAX. Would the exchange be a financial wash? Or would it be better to wait until the market goes down a bit to make the exchange?

Since your short-term capital gains are inconsequential, I would just make the exchange and get on the right AA target for the long run.
As for timing, I don't know the future. What if the market continues to rise for several more months? I wouldn't try to time the market.
Make the switch now when the tax consequences are minimal.

[sscritic]

Kelty:

I am not sure, but I think you might be confusing capital gains paid by the fund and capital gains you would realize if you sold your fund at a gain. VTINX paid a short term capital gain generated by its own sales of stocks and bonds that it holds of $0.021 a share on 12/27/2012. If you bought shares in July for $3000 and sell them today for $5000, you will have a $2000 gain. I am guessing the $18 refers to the distribution, but I could be wrong.

What do you see when you click on cost basis under balances and holdings? Those are what your gains would have been if you had sold yesterday.

[grabiner]

Something I'm confused about is the timing. Because the market is up, this is a good time to sell VTINX but a bad time to buy VBIAX. Would the exchange be a financial wash? Or would it be better to wait until the market goes down a bit to make the exchange?

What happened in the past is irrelevant; only the future will affect your returns. The best time to switch funds is when the new fund will go up more than the old fund; since you are switching to a higher stock allocation, you want to do this before the market goes up. However, I have no ability to predict whether the market will go up, and neither does anyone else who is offering advice.

Whether the exchange is right or wrong depends on the rest of your portfolio and your needs. I don't like this specific change; if you want a more aggressive one-fund portfolio, there are better diversified options. If you are not yet retired, you may want a Target Retirement fund other than the income fund, which will drop to 30% stocks several years after retirement. If you are already retired but still want 60% stock for the rest of your life, LifeStrategy Moderate Growth is better. And none of these is right for a taxable account if you also have an IRA, as you can choose a different allocation to reduce the tax bill.

[Kelty]

I am not sure, but I think you might be confusing capital gains paid by the fund and capital gains you would realize if you sold your fund at a gain. VTINX paid a short term capital gain generated by its own sales of stocks and bonds that it holds of $0.021 a share on 12/27/2012. If you bought shares in July for $3000 and sell them today for $5000, you will have a $2000 gain. I am guessing the $18 refers to the distribution, but I could be wrong.

What do you see when you click on cost basis under balances and holdings? Those are what your gains would have been if you had sold yesterday.

The total gain is $288--is this what you mean?

[Kelty]

What happened in the past is irrelevant; only the future will affect your returns. The best time to switch funds is when the new fund will go up more than the old fund; since you are switching to a higher stock allocation, you want to do this before the market goes up. However, I have no ability to predict whether the market will go up, and neither does anyone else who is offering advice.

Whether the exchange is right or wrong depends on the rest of your portfolio and your needs. I don't like this specific change; if you want a more aggressive one-fund portfolio, there are better diversified options. If you are not yet retired, you may want a Target Retirement fund other than the income fund, which will drop to 30% stocks several years after retirement. If you are already retired but still want 60% stock for the rest of your life, LifeStrategy Moderate Growth is better. And none of these is right for a taxable account if you also have an IRA, as you can choose a different allocation to reduce the tax bill.

I am retired and have no IRA. I already have some LifeStrategy Moderate Growth and was very pleased with its performance last year. Before I started this thread I compared LifeStrategy Moderate Growth and Balanced Index Admiral and decided on the Balanced Index Admiral for the sake of diversification. However, what are your thoughts about having an entire portfolio in LifeStrategy Moderate Growth?

[sscritic]

What do you see when you click on cost basis under balances and holdings? Those are what your gains would have been if you had sold yesterday.

The total gain is $288--is this what you mean?

The short-term capital gains are pretty inconsequential--only $18

Is that $270 plus $18 = $288? Is the $18 a different $18? Is the $18 the distribution you got in December? You asked about tax consequences. The consequences are different for short and long. To know the consequences, you need both numbers for selling today, but the distributions from December are irrelevant. Perhaps you could reveal all four numbers: long December, long today, short December, and short today. Then ignore anything from December.

As I read the other responses, your proposed switch does not seem to be highly regarded. I don't do asset allocations for other people, so I have no comment on that. I am just trying to help you understand the tax consequences if you were to make the switch.

[Kelty]

You asked about tax consequences. The consequences are different for short and long. To know the consequences, you need both numbers for selling today, but the distributions from December are irrelevant. Perhaps you could reveal all four numbers: long December, long today, short December, and short today. Then ignore anything from December.

Thank you for bearing with me.

Short December = $18 and Long December = zero
Short Today = $288 and Long Today = zero

So if I had sold the Target Retirement Income Fund yesterday, then I would pay short-term capital gains taxes on $288.

And the amount of that tax would be the total cost of exchanging the Target Retirement Income Fund for another Vanguard fund. (Except I assume that whatever fund I exchanged it for would accrue short-term capital gains taxes during its first year.)

Am I on the right track?

[damjam]

Am I on the right track?

I'm not certain.

Did you get the $288 figure using this formula:
Value Friday - Purchase Price = Capital Gain/Loss

If so, you are on the right track.

[sscritic]

He got it from Vanguard's website. They are probably using average basis, so $288 would be his gain if he had sold all of it yesterday. If he has never sold, then it wouldn't matter what basis method Vanguard is using or he uses.

He said he purchased the initial shares "nearly" a year ago. If he waits until it is a year and a day, I am guessing that most of the $288 will be long term and not short term. If there was only the single purchase with some shares added through reinvestment of dividends and capital gains, then I would be correct. If he reinvested nothing, then all the gains will be long-term when "nearly" becomes "more than."

[Kelty]

Many thanks to all three of you for un-confusing me.

During this process my thinking has evolved. Now I am debating between LifeStrategy Moderate Growth and a 60/40 combination of Total Stock, Total International, and Total Bond. LifeStrategy would be easier, but I think I would enjoy watching the fluctuations of the three individual index funds.

Even harder will be deciding WHEN.

[grabiner]

I am retired and have no IRA. I already have some LifeStrategy Moderate Growth and was very pleased with its performance last year. Before I started this thread I compared LifeStrategy Moderate Growth and Balanced Index Admiral and decided on the Balanced Index Admiral for the sake of diversification. However, what are your thoughts about having an entire portfolio in LifeStrategy Moderate Growth?

LifeStrategy Moderate Growth has better diversification, as it includes international stocks; Balanced Index holds only bonds and US stocks.

If you want a portfolio which requires no management, are in a low tax bracket, and the allocation will be correct for the rest of your life, then the LifeStrategy Moderate Growth is fine for a one-fund taxable portfolio. You won't have to worry about rebalancing because the account will stay balanced.

Note the italics. If you might want to change to a more conservative allocation later, then you should either use a Target Retirement fund (which becomes more conservative automatically) or the three individual funds. If you switch from LifeStrategy Moderate Growth to LifeStrategy Conservative Growth, you will pay capital-gains tax on the whole thing; if you have a 60/40 portfolio of individual funds and change to 40/60, you will pay capital-gains tax only on the 1/3 of the stock that you sold.

The reason you should only use LifeStrategy in a low tax bracket is that you would prefer municipal bonds rather than Total Bond Market if you are in a high tax bracket.

[Kelty]

If you want a portfolio which requires no management, are in a low tax bracket, and the allocation will be correct for the rest of your life, then the LifeStrategy Moderate Growth is fine for a one-fund taxable portfolio. You won't have to worry about rebalancing because the account will stay balanced.

Note the italics. If you might want to change to a more conservative allocation later, then you should either use a Target Retirement fund (which becomes more conservative automatically) or the three individual funds. If you switch from LifeStrategy Moderate Growth to LifeStrategy Conservative Growth, you will pay capital-gains tax on the whole thing; if you have a 60/40 portfolio of individual funds and change to 40/60, you will pay capital-gains tax only on the 1/3 of the stock that you sold.

The reason you should only use LifeStrategy in a low tax bracket is that you would prefer municipal bonds rather than Total Bond Market if you are in a high tax bracket.

I am in a low tax bracket.

I might as well keep the $11,000 of LifeStrategy Moderate I already have.

However, I plan to continue adding funds to my Vanguard account, so I think a 60/40 mix of Total Stock, Total Bond, and Total International will work well for me. Advantages would include the following:
* I could easily rebalance.
* I could easily make the mix more conservative as I get older.
* I could switch from Investor to Admiral when the funds reach $10,000.

Here are more questions:
* Is there a tax consequence for switching from Investor to Admiral?
* Am I penalized if a Vanguard fund drops below its minimum ($3,000 or $10,000 or whatever) due to market fluctuation?
* Should I use FIFO instead of AvCost for my cost basis?

Thank you very much for taking the time to respond. Without the support of Bogleheads, I probably would not feel secure enough to invest in Vanguard funds.

[sscritic]

Here are more questions:
* Is there a tax consequence for switching from Investor to Admiral?
* Am I penalized if a Vanguard fund drops below its minimum ($3,000 or $10,000 or whatever) due to market fluctuation?
* Should I use FIFO instead of AvCost for my cost basis?

NO
NO, not immediately.
That's a really long discussion. Many people like specific ID. The rules now allow you to change, whereas before some changes only went one direction. Specific ID gives you the most flexibility, as you can sell any of your shares when you want to sell. FIFO is the same, except that you always sell your oldest shares first (it is like you used specific ID, but always chose your oldest share when you identify the ones to sell).

[Kelty]

* Is there a tax consequence for switching from Investor to Admiral?
* Am I penalized if a Vanguard fund drops below its minimum ($3,000 or $10,000 or whatever) due to market fluctuation?
* Should I use FIFO instead of AvCost for my cost basis?

Answers to my three questions:

* A Vanguard site says there is no tax consequence for switching from Investor shares to Admiral shares. Does this mean that the Investor shares are not actually sold when they switch to Admiral shares?

* A Bogleheads thread says I should switch to Admiral shares as soon as a fund reaches $10,000 and that those shares will remain Admiral shares even if the market drops the fund below $10,000. Therefore, a market drop to below $10,000 apparently would not incur a penalty. I hope I am right about this.

* Thanks for trying to enlighten me, sscritic. According to Vanguard FAQs I can change my cost basis at any time, so it sounds like I'd better keep my cost basis at default (AvCost) until there is reason to change.

[SpringMan]

To switch to admiral shares do NOT do an exchange. Do a convert to admiral shares. You can do this on the website or call Vanguard and have them do it. Conversion will not be a taxable event. If your fund drops below the minimum for admiral shares due to market conditions, Vanguard will generally not demote your fund to investor shares, although they have the right. If you sell shares or exchange out shares resulting in dropping below the minimum they will, but first they will send you a letter giving you an opportunity to add funds. No penalties are involved just demotion of the share class.

[Kelty]

To switch to admiral shares do NOT do an exchange. Do a convert to admiral shares. You can do this on the website or call Vanguard and have them do it. Conversion will not be a taxable event. If your fund drops below the minimum for admiral shares due to market conditions, Vanguard will generally not demote your fund to investor shares, although they have the right. If you sell shares or exchange out shares resulting in dropping below the minimum they will, but first they will send you a letter giving you an opportunity to add funds. No penalties are involved just demotion of the share class.

Thank you very much for providing this very important information.

[grabiner]

* Is there a tax consequence for switching from Investor to Admiral?

No.

Am I penalized if a Vanguard fund drops below its minimum ($3,000 or $10,000 or whatever) due to market fluctuation?

No. Vanguard can downgrade Admirals when the fund balance drops below the Admiral minimum, but it generally only does so when your own withdrawals took it below the fund.

Should I use FIFO instead of AvCost for my cost basis?

You should use specific identification, so that you can sell shares to minimize your overall tax burden. Usually, you will want to minimize gains, but there are some exceptions. If you are in the 15% tax bracket and not taking Social Security, you will pay no tax on capital gains that leave you in the 15% bracket, so you might want to take more gains than necessary when you sell. In another year, when you are in the phase-in of Social Security taxation, every $1 of capital gains is taxed at 0% but makes 85 cents of Social Security taxed at 15%, so you want to minimize gains in that year. And any unrealized gains you still have when you die will not be taxed at all.

[Kelty]

You should use specific identification, so that you can sell shares to minimize your overall tax burden. Usually, you will want to minimize gains, but there are some exceptions. If you are in the 15% tax bracket and not taking Social Security, you will pay no tax on capital gains that leave you in the 15% bracket, so you might want to take more gains than necessary when you sell. In another year, when you are in the phase-in of Social Security taxation, every $1 of capital gains is taxed at 0% but makes 85 cents of Social Security taxed at 15%, so you want to minimize gains in that year. And any unrealized gains you still have when you die will not be taxed at all.

Uh-oh. There's another steep learning curve in my future.

[grabiner]

You should use specific identification, so that you can sell shares to minimize your overall tax burden. Usually, you will want to minimize gains, but there are some exceptions. If you are in the 15% tax bracket and not taking Social Security, you will pay no tax on capital gains that leave you in the 15% bracket, so you might want to take more gains than necessary when you sell. In another year, when you are in the phase-in of Social Security taxation, every $1 of capital gains is taxed at 0% but makes 85 cents of Social Security taxed at 15%, so you want to minimize gains in that year. And any unrealized gains you still have when you die will not be taxed at all.

Uh-oh. There's another steep learning curve in my future.

But it can save you hundreds of dollars, so it's worthwhile whenever you sell part of a fund. When I needed to sell $5000 of a mutual fund a few years ago, FIFO would have sold shares for which I had paid $3000 ($300 tax), and average basis would have sold shares for which I had paid $4000 ($150 tax), while specific ID allowed me to sell shares for $5032 for which I had paid $5000 ($32 short-term gain, $8 tax in my 25% bracket).

[Kelty]

But it can save you hundreds of dollars, so it's worthwhile whenever you sell part of a fund. When I needed to sell $5000 of a mutual fund a few years ago, FIFO would have sold shares for which I had paid $3000 ($300 tax), and average basis would have sold shares for which I had paid $4000 ($150), while specific ID allowed me to sell shares for $5032 for which I had paid $5000 ($32 short-term gain, $8 tax in my 25% bracket).

Your example helps a lot toward my understanding of cost basis.

If and when I decide to sell part of a mutual fund, would it be too complicated for me to figure out for myself (without an accountant) which cost basis is most cost effective at that particular time?

[grabiner]

But it can save you hundreds of dollars, so it's worthwhile whenever you sell part of a fund. When I needed to sell $5000 of a mutual fund a few years ago, FIFO would have sold shares for which I had paid $3000 ($300 tax), and average basis would have sold shares for which I had paid $4000 ($150 tax), while specific ID allowed me to sell shares for $5032 for which I had paid $5000 ($32 short-term gain, $8 tax in my 25% bracket).

Your example helps a lot toward my understanding of cost basis.

If and when I decide to sell part of a mutual fund, would it be too complicated for me to figure out for myself (without an accountant) which cost basis is most cost effective at that particular time?

No, it won't be a problem. If you buy the fund now, Vanguard will keep a record of your cost basis; if you have older (non-covered) shares, you can keep a record in accounting software such as Quicken, or in a spreadsheet. It is almost always right to sell the highest-basis shares, so if your records indicate that you have shares bought at $25 and shares bought at $30, you should sell the shares bought at $30, and specify those shares when you sell online.

[Kelty]

If and when I decide to sell part of a mutual fund, would it be too complicated for me to figure out for myself (without an accountant) which cost basis is most cost effective at that particular time?

No, it won't be a problem. If you buy the fund now, Vanguard will keep a record of your cost basis; if you have older (non-covered) shares, you can keep a record in accounting software such as Quicken, or in a spreadsheet. It is almost always right to sell the highest-basis shares, so if your records indicate that you have shares bought at $25 and shares bought at $30, you should sell the shares bought at $30, and specify those shares when you sell online.

The fog seems to be lifting. I see that the share price of all my Vanguard transactions, including purchases and earnings, is listed under Transaction History in my Vanguard account.

I also see that Vanguard apparently does not yet provide an online form for specifying shares when I use Specific Identification as my cost basis. So how is this handled?

I don't have older shares.

[Minot]

I purchased VTINX nearly a year ago, and it has earned something over $500 so far. The short-term capital gains are pretty inconsequential--only $18.

Vanguards Fund Profile for VTINX says today's price/share is $12.33, and the one year historical low is $12.34--so either OP has held his/her shares longer than one year, or she/he has a small capital loss. Or VG fund profile is wrong. Or I'm misunderstanding something.

Minot