Comparing tax efficiency of some Vanguard funds.

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GaryA505
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Comparing tax efficiency of some Vanguard funds.

Post by GaryA505 »

I've been comparing tax efficiency of some Vanguard funds and I have a question. This chart shows the M* Tax Cost Ratio for some BHs favorite tax-efficient funds:
VTSMX Total Stock Market Index
VTCLX Tax-Managed Capital Appreciation
VTMFX Tax-Managed Balanced

I also added VBINX Balanced Index Fund, expecting it to not be anywhere as tax-efficient as the others, but it seems to be just about as good. I also added Wellesley Income and Wellington which appear to be much less tax-efficient, as expected. So I don't understand why VBINX appears to be just about as tax-efficient as the "usual suspects". Can anyone explain this?

Also, the historical tax-adjusted return for VBINX (Balanced Index) is higher than for VTMFX (Tax-managed Balanced). I know VTMFX has munis instead of taxable bonds, but it appears that the tax savings from the munis isn't enough to overcome the extra yield from the taxable bonds. Is this correct?

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livesoft
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Re: Comparing tax efficiency of some Vanguard funds.

Post by livesoft »

The M* tax cost ratio is unreliable and probably wrong for most investors.

See this thread: viewtopic.php?t=208818
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aristotelian
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Re: Comparing tax efficiency of some Vanguard funds.

Post by aristotelian »

VBINX is 60% stock/40% Bond, VTMFX is 50% stock/50% muni. Not sure why they do it that way, but that explains why returns are higher for VBINX even though VTMFX is more efficient.
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Re: Comparing tax efficiency of some Vanguard funds.

Post by GaryA505 »

aristotelian wrote:VBINX is 60% stock/40% Bond, VTMFX is 50% stock/50% muni. Not sure why they do it that way, but that explains why returns are higher for VBINX even though VTMFX is more efficient.
Yes, I get why VBINX has had higher returns, but I still am curious why it's not significantly less tax-efficient than VTMFX.
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Re: Comparing tax efficiency of some Vanguard funds.

Post by welderwannabe »

aristotelian wrote:VBINX is 60% stock/40% Bond, VTMFX is 50% stock/50% muni. Not sure why they do it that way, but that explains why returns are higher for VBINX even though VTMFX is more efficient.
Assuming you are referring to why VTMFX has 50% munis, I believe it is due to the fact that a mutual fund must hold more than 50% munis for the muni bond dividends to be tax exempt. Any less than 50% and it loses its tax exempt status.
William Baldwin wrote: 4. Muni Interest. A fund that owns “municipal” bonds (bonds sold by states, cities, nonprofits and so on) can flow through federally tax-exempt interest to its investors. To do so, the fund must have at least 50% of its assets invested in these bonds. No surprise that funds mixing stocks and munis stay on the safe side of the barrier. The Vanguard Tax-Managed Balanced Fund (VTMFX), for example, is 52% invested in tax-exempt bonds.
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Re: Comparing tax efficiency of some Vanguard funds.

Post by aristotelian »

GaryA505 wrote:
aristotelian wrote:VBINX is 60% stock/40% Bond, VTMFX is 50% stock/50% muni. Not sure why they do it that way, but that explains why returns are higher for VBINX even though VTMFX is more efficient.
Yes, I get why VBINX has had higher returns, but I still am curious why it's not significantly less tax-efficient than VTMFX.
Where are you getting that? The tax cost number is .17 lower. Are you thinking it should be even lower? One possibility is state taxes -- the muni funds in VTMFX are only going to be exempt from Federal.
Last edited by aristotelian on Thu Aug 03, 2017 10:55 am, edited 1 time in total.
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Re: Comparing tax efficiency of some Vanguard funds.

Post by triceratop »

GaryA505 wrote:
aristotelian wrote:VBINX is 60% stock/40% Bond, VTMFX is 50% stock/50% muni. Not sure why they do it that way, but that explains why returns are higher for VBINX even though VTMFX is more efficient.
Yes, I get why VBINX has had higher returns, but I still am curious why it's not significantly less tax-efficient than VTMFX.
Even if that were true (it isn't, as the previous reply pointed out), I would make this point:


*why Morningstar says it is significantly less tax-efficient than VTMFX. If you do not know Morningstar's algorithm and its correctness and suitability to your situation, it is indistinguishable from magic, no?

That is why I would use the methods pointed out by livesoft above.
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Re: Comparing tax efficiency of some Vanguard funds.

Post by blackcat4 »

I have the same question, and I am not clear on what the answer is based on the posts above.

Comparing apples to apples, how much more tax efficient is the tax managed balanced index vs the balanced index? (I say apple to apples, because I realize one is 50/50 and the other is 60/40.)

I have the balanced index in my retirement account and am deciding between the tax managed balanced index and the balanced index for my taxable. (My bracket fluctuates between 28% and 33% and I have no state income tax.) Is the tax managed that much more tax efficient where it's worth it? Is there a way to compare the two from a tax efficiency standpoint, eliminating the variable of their different asset allocation? (Put another way, is there a way to compare the two tax-wise while hypothetically assuming they are both, say, 50/50?)
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Re: Comparing tax efficiency of some Vanguard funds.

Post by GaryA505 »

aristotelian wrote:
GaryA505 wrote:
aristotelian wrote:VBINX is 60% stock/40% Bond, VTMFX is 50% stock/50% muni. Not sure why they do it that way, but that explains why returns are higher for VBINX even though VTMFX is more efficient.
Yes, I get why VBINX has had higher returns, but I still am curious why it's not significantly less tax-efficient than VTMFX.
Where are you getting that? The tax cost number is .17 lower. Are you thinking it should be even lower? One possibility is state taxes -- the muni funds in VTMFX are only going to be exempt from Federal.
I don't consider a difference of 0.17 significant, when compared with the large difference in tax-efficiency between VTMFX and some other funds like VWINX and VWELX, and that fact that these TCR values bounce around a bit over time.
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Re: Comparing tax efficiency of some Vanguard funds.

Post by aristotelian »

GaryA505 wrote: Where are you getting that? The tax cost number is .17 lower. Are you thinking it should be even lower? One possibility is state taxes -- the muni funds in VTMFX are only going to be exempt from Federal.
I don't consider a difference of 0.17 significant, when compared with the large difference in tax-efficiency between VTMFX and some other funds like VWINX and VWELX, and that fact that these TCR values bounce around a bit over time.[/quote]

VWINX and VWELX are actively managed funds. This means they are going to have capital gains distributions that index funds are not going to have. They are not really comparable to VTMFX or VBINX.

.17% is still significant. Keep in mind, that is a % of your account balance that you save or lose due to taxation. You would never go for a comparable index fund with .17% higher expense ratio.
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Re: Comparing tax efficiency of some Vanguard funds.

Post by GaryA505 »

blackcat4 wrote:I have the same question, and I am not clear on what the answer is based on the posts above.

Comparing apples to apples, how much more tax efficient is the tax managed balanced index vs the balanced index? (I say apple to apples, because I realize one is 50/50 and the other is 60/40.)

I have the balanced index in my retirement account and am deciding between the tax managed balanced index and the balanced index for my taxable. (My bracket fluctuates between 28% and 33% and I have no state income tax.) Is the tax managed that much more tax efficient where it's worth it? Is there a way to compare the two from a tax efficiency standpoint, eliminating the variable of their different asset allocation? (Put another way, is there a way to compare the two tax-wise while hypothetically assuming they are both, say, 50/50?)
That is what I was getting at. Balanced Index (VBINX) has slightly better return (well, at least it has in the past) but is slightly less tax-efficient. Tax-Managed Balanced (VTMFX) has slightly less return but slightly better tax-efficiency.

I am also considering these two for my taxable account. Or I might just do a VTSMX/VWITX split, which has the advantage that when I get into retirement I can sell which ever is higher. Can't do that with VBINX or VTMFX.
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Re: Comparing tax efficiency of some Vanguard funds.

Post by GaryA505 »

There another significant difference. For 2016, TM Balanced has a QDI of 100% where Balanced Index is only 53%.

https://personal.vanguard.com/us/insigh ... -2016?Sc=1
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Re: Comparing tax efficiency of some Vanguard funds.

Post by triceratop »

GaryA505 wrote:There another significant difference. For 2016, TM Balanced has a QDI of 100% where Balanced Index is only 53%.

https://personal.vanguard.com/us/insigh ... -2016?Sc=1
Have you looked at the link livesoft provided and tried to compute the actual honest-to-goodness tax efficiency numbers? Until you do that it's all just speculation, really. There is subtlety here which you need to unpack and analyze for an actual answer.

In particular, for your observation, I suspect for TM Balanced the muni income is counted as tax-exempt interest as opposed to a dividend which may be qualified or not. I further suspect that for Balanced Index the bond interest is not counted as such. The real test is to compute the tax equivalent yield of the bond portfolio along with the dividend and the dividend characteristics of the stock portion of the fund.
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Re: Comparing tax efficiency of some Vanguard funds.

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triceratop wrote:
GaryA505 wrote:There another significant difference. For 2016, TM Balanced has a QDI of 100% where Balanced Index is only 53%.

https://personal.vanguard.com/us/insigh ... -2016?Sc=1
Have you looked at the link livesoft provided and tried to compute the actual honest-to-goodness tax efficiency numbers? Until you do that it's all just speculation, really. There is subtlety here which you need to unpack and analyze for an actual answer.

In particular, for your observation, I suspect for TM Balanced the muni income is counted as tax-exempt interest as opposed to a dividend which may be qualified or not. I further suspect that for Balanced Index the bond interest is not counted as such. The real test is to compute the tax equivalent yield of the bond portfolio along with the dividend and the dividend characteristics of the stock portion of the fund.
Yes I have looked at the spreadsheet a couple of times, but it's for ETFs. It would be nice if someone has already plugged-in the 2016 numbers for the most popular Vanguard mutual funds, otherwise I'll try to do it when I have time.
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Re: Comparing tax efficiency of some Vanguard funds.

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GaryA505 wrote:
triceratop wrote:
GaryA505 wrote:There another significant difference. For 2016, TM Balanced has a QDI of 100% where Balanced Index is only 53%.

https://personal.vanguard.com/us/insigh ... -2016?Sc=1
Have you looked at the link livesoft provided and tried to compute the actual honest-to-goodness tax efficiency numbers? Until you do that it's all just speculation, really. There is subtlety here which you need to unpack and analyze for an actual answer.

In particular, for your observation, I suspect for TM Balanced the muni income is counted as tax-exempt interest as opposed to a dividend which may be qualified or not. I further suspect that for Balanced Index the bond interest is not counted as such. The real test is to compute the tax equivalent yield of the bond portfolio along with the dividend and the dividend characteristics of the stock portion of the fund.
Yes I have looked at the spreadsheet a couple of times, but it's for ETFs. It would be nice if someone has already plugged-in the 2016 numbers for the most popular Vanguard mutual funds, otherwise I'll try to do it when I have time.
The ETFs have the same tax efficiency as the corresponding Admiral shares mutual fund.

The (Tax-managed) Balanced Index funds are not overly popular so you have to do a bit of legwork to calculate the numbers.
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Re: Comparing tax efficiency of some Vanguard funds.

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I didn't really check, but I just assumed that there is no corresponding ETF for VBINX/VBIAX or VTMFX. Could you use a mixture of AGG&BND for VBIAX (and do the math)? The spreadsheet probably wouldn't work for VTMFX, because it's equivalent to about 49% VTCLX (TN Cap Apprec, a managed fund) and 51% VWITX.
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Re: Comparing tax efficiency of some Vanguard funds.

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GaryA505 wrote:I didn't really check, but I just assumed that there is no corresponding ETF for VBINX/VBIAX or VTMFX. Could you use a mixture of AGG&BND for VBIAX (and do the math)? The spreadsheet probably wouldn't work for VTMFX, because it's equivalent to about 49% VTCLX (TN Cap Apprec, a managed fund) and 51% VWITX.
The closest ETF equivalent would be 49% VONE (Russell 1000 ETF; the S&P 500 VOO is a similar index with lower costs) and 51% VTEB (Tax-Exempt Bond ETF). However, TM Capital Appreciation is slightly more tax-efficient than VONE or VOO because it selects stocks for a lower dividend yield.
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Re: Comparing tax efficiency of some Vanguard funds.

Post by GaryA505 »

It would help if we could put some approximate numbers on this. What does difference in tax-efficiency real mean in real dollars? Let's use an example for an approximation. We'll ignore the M* TCR for now.

US tax rate: 25%
State tax rate: 5%

Two funds, Fund A and Fund B.
For simplicity, assume QDI of 100% for both.
Investment of $10000 in each fund.

Fund A distribution: 1% ($100/yr)
Fund B distribution: 2% ($200/yr)

What's the difference in annual taxes paid before sale of funds?

I know, it's way more complicated than that, but this is just an approximation for illustration purposes.
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Re: Comparing tax efficiency of some Vanguard funds.

Post by triceratop »

GaryA505 wrote:I didn't really check, but I just assumed that there is no corresponding ETF for VBINX/VBIAX or VTMFX. Could you use a mixture of AGG&BND for VBIAX (and do the math)? The spreadsheet probably wouldn't work for VTMFX, because it's equivalent to about 49% VTCLX (TN Cap Apprec, a managed fund) and 51% VWITX.
There is no corresponding ETF, but that does not mean you cannot add a new column with the numbers specific to VBINX and VTMFX. Nothing about the spreadsheet is specific to ETFs, I just happened to use them. In fact there are some Fidelity mutual funds on the list.
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