VXUS and Muni Bonds tax efficiency

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Topic Author
sgx
Posts: 2
Joined: Sun Sep 28, 2014 1:44 am

VXUS and Muni Bonds tax efficiency

Post by sgx »

Hello All,

I'm just getting around to setting up a taxable account, and as per the Principles of tax efficient fund placement, I was planning on placing VXUS in my taxable account. But, when I look at this ETF's tax-adjusted returns and tax-cost ratio on Morningstar, it doesn't seem to be that tax-efficient:

http://performance.morningstar.com/fund ... ture=en-US

VTI itself seems to be better. Am I misinterpreting these tax-cost ratio numbers?

Regarding Municipal Bonds/ETFS, when I look at the tax-adjusted returns for MUB or VWITX, as expected, I see the "Returns after taxes on distributions" to be the same as "Returns before taxes".

https://personal.vanguard.com/us/funds/ ... =INT#tab=1

But this table in the Bogleheads Wiki says that cost of Muncipal Bond in a taxable account is 1.5%
http://www.bogleheads.org/wiki/Principl ... _tax_costs

I understand that taxable account is a good place to hold Municipal Bonds/ETFs. Is my understanding correct?
livesoft
Posts: 86075
Joined: Thu Mar 01, 2007 7:00 pm

Re: VXUS and Muni Bonds tax efficiency

Post by livesoft »

Please read this from forum member grabiner about Morningstar tax-cost ratio (it is often invalid):
http://www.bogleheads.org/forum/viewtop ... 7#p1786637

As for tax efficiency of VTI versus VXUS, they are close, but can change, too. It may even depend on one's marginal income tax bracket and the rest of one's tax return. See, for example, this thread: http://www.bogleheads.org/forum/viewtop ... 1&t=129164

P.S. Welcome to the forum!
Wiki This signature message sponsored by sscritic: Learn to fish.
User avatar
ogd
Posts: 4876
Joined: Thu Jun 14, 2012 11:43 pm

Re: VXUS and Muni Bonds tax efficiency

Post by ogd »

sgx wrote:But this table in the Bogleheads Wiki says that cost of Muncipal Bond in a taxable account is 1.5%
http://www.bogleheads.org/wiki/Principl ... _tax_costs

I understand that taxable account is a good place to hold Municipal Bonds/ETFs. Is my understanding correct?
While I wouldn't put an exact number on it, municipal bonds in taxable accounts are not a slam dunk. This point from the Wiki is key:
Principles of tax-efficient placement Wiki wrote:Municipal bond funds have a hidden cost; while their interest incomes are not subject to federal tax, they usually earn less than corporate or treasury bond funds of comparable risk.
If your tax bracket is low enough (say 25% or below), muni bonds are not even preferable to taxable bonds, let alone stocks, because you're essentially paying the same price as other market participants who benefit much more from the tax discount and you're getting a bad deal as a result. This might be a little hard to wrap your head around, but it's nevertheless true and it explains why currently California bonds (VCADX) are paying slightly less than Treasuries (VFIUX) despite being considerably riskier.

VXUS is theoretically more tax efficient than VTI because of the foreign tax credit, but currently international stocks are depressed and pay larger dividends. However, this won't always be the case and it will be extremely expensive to switch in the future, so I'd go with VXUS in taxable nonetheless.
User avatar
baw703916
Posts: 6681
Joined: Sun Apr 01, 2007 1:10 pm
Location: Seattle

Re: VXUS and Muni Bonds tax efficiency

Post by baw703916 »

Municipal bonds have no tax costs per se (assuming the fund isn't distributing capital gains and that you either aren't subject to AMT or you own a fund whose bonds aren't subject to AMT).

The "tax cost" is that tax-exempt bonds generally pay lower interest rates than similar taxable bonds. That depends on the market rates for taxable vs. tax-exempt bonds. For the last few years interest rates on taxable bonds have been anomalously low, both in an absolute sense and relative to tax-exempt bonds. This has reduced the tax cost: it has been nowhere near 1.5% in recent years. Recently the yields on taxable bonds have been rising relative to those of tax-exempt bonds, which means the tax cost is going up.
Most of my posts assume no behavioral errors.
stlutz
Posts: 5585
Joined: Fri Jan 02, 2009 12:08 am

Re: VXUS and Muni Bonds tax efficiency

Post by stlutz »

Welcome to the forum!

The problem with VXUS is that it has a relatively high dividend yield. If you put this in taxable, you do get the benefit of the foreign tax credit but you still have to pay taxes on those higher dividends. As such, it really isn't the case that there is some huge tax advantage to putting international stocks into taxable accounts.

On muni bonds, yes, you would *only* put these in a taxable account. The direct tax cost for those is very small (depending upon your state income tax rate). However, there is an indirect cost. Muni bond prices reflect their tax exempt status--they yield less in the first place. This is the the "tax cost" that was being referred to.

In general, it is worth noting that the wiki page on tax-efficient location is probably one of the most contentious issues on this board. Some find it to be flat out misleading. I personally think it's not that helpful. If you want to dig into this question further, I would suggest doing a forum search for discussions on the topic. Or, feel free to raise further questions in this thread and people will go at it. :happy
am
Posts: 4233
Joined: Sun Sep 30, 2007 9:55 am

Re: VXUS and Muni Bonds tax efficiency

Post by am »

Is total world stock from Vanguard more efficient that total us or international?
User avatar
baw703916
Posts: 6681
Joined: Sun Apr 01, 2007 1:10 pm
Location: Seattle

Re: VXUS and Muni Bonds tax efficiency

Post by baw703916 »

am wrote:Is total world stock from Vanguard more efficient that total us or international?
It should be quite similar.
Most of my posts assume no behavioral errors.
TIAX
Posts: 1434
Joined: Sat Jan 11, 2014 11:19 am

Re: VXUS and Muni Bonds tax efficiency

Post by TIAX »

am wrote:Is total world stock from Vanguard more efficient that total us or international?
Vanguard World Stock Index Fund tax distributions
User avatar
grabiner
Advisory Board
Posts: 35307
Joined: Tue Feb 20, 2007 10:58 pm
Location: Columbia, MD

Re: VXUS and Muni Bonds tax efficiency

Post by grabiner »

am wrote:Is total world stock from Vanguard more efficient that total us or international?
It should be just as tax-efficient as the individual funds, as it holds the same stocks and should not distribute capital gains.

It might actually have a slightly lower tax cost, but for the wrong reason: Total World Stock has higher expenses than Total Stock Market and Total International, and expenses come out of the taxable dividend yield.
Wiki David Grabiner
Topic Author
sgx
Posts: 2
Joined: Sun Sep 28, 2014 1:44 am

Re: VXUS and Muni Bonds tax efficiency

Post by sgx »

Thanks for answering my questions, all.
Post Reply