Is there tax advantage to international VG dicing?

[Half Way to Heck]

Hi All,

Is there a tax advantage to holding VEA + VSS + VWO at market weightings instead of holding Vanguard Total International? (eg VTIAX) (I'm aware that this slicing neglects Canada.)

Thanks for your thoughts and time. Best,

HWTH

[kenyan]

A tax advantage? Possible, but not likely. Prior to 2010(ish) there may have been one, as Vanguard Total International used to be a fund-of-funds, and was ineligible for the foreign tax credit. It is no longer constructed in that manner, and is eligible for foreign tax credit.

The possible tax advantage would be if some of these market segments dropped while others did not, allowing you to tax-loss harvest just the losers.

I don't consider it worth the trouble, as you'd be paying more in expenses to hold the funds individually.

[Half Way to Heck]

What I'm wondering about is that VEA, the bulk of the weighting, aims for 100% qualified dividends whereas the other funds don't.

[abuss368]

I am of the opinion it is not worth the trouble. Vanguard's Lifestyle and Target funds also use the Total International. Overall I am pleased with this fund - admiral shares and now quarterly dividends. I would like to see the expense ratio decline more from .18 however.

[stan1]

What I'm wondering about is that VEA, the bulk of the weighting, aims for 100% qualified dividends whereas the other funds don't.

I think what you are getting at is the fact that VEA is a share class of Tax Managed International (not Developed Markets Index).

Vanguard Tax-Managed International Fund uses a tax-efficient approach to track the investment performance of the MSCI EAFE Index, an unmanaged benchmark representing international stocks. The advisor uses portfolio optimization techniques to select a sample of stocks that, in aggregate, reflect the characteristics of the benchmark index. Vanguard uses proprietary software to implement trading decisions that accommodate cash flow and maintain close correlation with index characteristics. In addition, a disciplined sell process minimizes the realization of net capital gains and may include the realization of losses to offset unavoidable gains. The experience and stability of Vanguard’s Equity Investment Group have permitted continuous refinement of indexing techniques designed to minimize tracking error and provide tax-efficient returns.

I don't think it will make much difference. Developed Markets was previously a "fund of funds" so Vanguard couldn't do an ETF share class. I would go with the the single total market fund if you want market weightings (especially since you are talking about a taxable account where rebalancing is best done only with new money being invested).

[Random Walker]

Taxes are only one type of cost. There are all sorts of costs associated with a fund: trading costs, expense ratios, tax consequences, and a bunch of stuff I don't know a thing about. That being said, I think the most cost efficient way to hold a portfolio is through the use of whole market funds. Whole market funds generally have lower expense ratios, fewer internal trading costs, and are more tax efficient. And you can use a tax managed whole market fund as well!
Now, using whole market funds does not mean you can't tilt a portfolio in any way one desires. For example, if one wanted to hold more Japan than is available in a total international fund, it would probably be best to still hold the total international fund and a smaller amount of the Pacific fund than to hold larger amounts of individual Europe, Pacific, and EM funds. I think that the potential rebalancing benefits and tax loss harvesting benefits of completely chopping the portfolio up would not outweigh the cost benefits of using as much as possible the whole market funds.

Dave

[Phineas J. Whoopee]

Hi All,

Is there a tax advantage to holding VEA + VSS + VWO at market weightings instead of holding Vanguard Total International? (eg VTIAX) (I'm aware that this slicing neglects Canada.)

Thanks for your thoughts and time. Best,

HWTH

Hi HWTH,

I never have been able to see any reason to hold a market-weight index in separate funds when there is a single, self-rebalancing fund available for the same fee. What would you do that the index fund manager wouldn't?

If for good reasons you wanted to differ from the index weightings, then yes, doing what you said would make sense.

PJW

P.S. - Are you in a handbasket?

[grabiner]

There is a possible tax advantage to the three-fund combination of 65% VEA + 20% VWO + 15% VSS, because VEA has 100% qualified dividends, while the developed markets stocks in other international funds have only about 80% qualified dividends. In addition, at current expense ratios, the three-fund combination costs a few basis points less than VXUS.

The downside is that you may have your own tax costs if you have to rebalance; VXUS rebalances itself. In addition, VSS might distribute capital gains; few Vanguard stock ETFs distribute gains, but VSS distributed them in its first two years. (Part of the reason is that VSS was started near the 2009 market bottom, and thus had an unusually large amount of gains in its first year.)

Normally, I would recommend just using VXUS (or the mutual fund version, Total International) if you want to hold everything at market weight. But if you will need to hold three funds anyway because you overweight small-cap and emerging markets, then the three-fund combination might be better. (I hold the three funds myself, actually four because I use EEMS for emerging markets small-cap to complete my overweightings of small-cap and emerging.)

[Half Way to Heck]

Thank you all for the thoughtful replies.

I'd like to pose another question. I wonder if anyone has compared the magnitude of the tax savings to the turnover and rebalancing costs. Unlike David, I'm only slightly overweighting VSS and VWO, so the bulk of my international will be either Total International or VEA+VSS+VWO. I presume that the slicing approach will suffer more turnover costs over 25 years, and David already mentioned the rebalancing costs. I'm not savvy enough to know if one effect dwarfs the other or if it's a wash. (I'm willing to assume the Total International ER may come down over time)

Per the bogleheads wiki, for the top tax bracket, Total International tax costs (2004-2011 averages) are 0.36% / 0.85% depending on whether 2012 or 2013 cap gains taxes apply. VEA tax costs (2004-2011 averages) are 0.17% / 0.85%.

(http://www.bogleheads.org/wiki/Vanguard_Tax_Managed_International_Fund_Tax_Distributions )
(http://www.bogleheads.org/wiki/Vanguard_Total_International_Stock_Index_Fund_Tax_Distributions)

Per Swensen's 2005 book, For a hypothetical 100% annual portfolio turnover of the largest 500 securities, you would lose 0.5% of the principle in market impact. If we guestimate that the sliced portfolio turnover is at most 20% per year, you might guestimate 0.1% market impact (although I doubt it's a linear relationship) which wouldn't seem to be enough to outweigh the tax benefit with 2012 tax rates. But I have no idea how to model this. Help?