tax consequences of converting Vanguard MFs to ETFs

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Wade Garrett
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tax consequences of converting Vanguard MFs to ETFs

Post by Wade Garrett » Fri Jan 12, 2018 8:51 am

I have been considering converting 3 Vanguard mutual funds (MFs) that I hold to the corresponding ETF share class of the same fund. I hold these 3 MFs in a taxable account and each have unrealized gains associated with them. The reason I've been considering making this switch is because my understanding has always been that ETFs are generally more tax efficient than MFs because MFs must realize some of their gains in a given year whereas ETFs do not.

However, when doing some research on this topic, I discovered past bogleheads threads that indicate there is no difference in tax efficiency between Vanguard MF and ETF share classes of the same fund. Is this true? If it is, does that mean my understanding that ETFs are generally more tax efficient than MFs has been wrong all along? Or is this something that is just unique to Vanguard with MF vs ETF share classes of the same fund?

What am I missing? Can someone please briefly explain?

onourway
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Re: tax consequences of converting Vanguard MFs to ETFs

Post by onourway » Fri Jan 12, 2018 8:56 am

Vanguard ETF's and Mutual Funds have the same tax efficiency because the ETF is simply a share class of the mutual fund. Vanguard has a patent on this method, so it is proprietary for now.

Even if this were not the case, I would be hard-pressed to believe it would be worth paying capital gains in order to switch between two already very tax efficient funds.

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Re: tax consequences of converting Vanguard MFs to ETFs

Post by livesoft » Fri Jan 12, 2018 9:03 am

It is something unique to Vanguard mutual funds and ETFs -- as long as the mutual fund has an ETF share class. Not all Vanguard mutual funds have an ETF share class. And some Vanguard mutual funds with an ETF share class are not tax efficient and neither is the ETF share class (VGSIX and VNQ, VBTLX and BND, come to mind).

But other ETFs are generally more tax-efficient than index funds offered by non-Vanguards. There are few active threads questioning by Fidelity Total Stock Market Index fund (FSTVX) is paying capital gains distributions every year when the ITOT iShares ETF does not.

And certainly passively-managed low-expense-ratio index funds are more tax efficient than actively-managed funds. Beware that some ETFs are actively-managed.

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Re: tax consequences of converting Vanguard MFs to ETFs

Post by indexfundfan » Fri Jan 12, 2018 9:12 am

onourway wrote:
Fri Jan 12, 2018 8:56 am
Vanguard ETF's and Mutual Funds have the same tax efficiency because the ETF is simply a share class of the mutual fund. Vanguard has a patent on this method, so it is proprietary for now.

Even if this were not the case, I would be hard-pressed to believe it would be worth paying capital gains in order to switch between two already very tax efficient funds.
You don't have to pay capital gains tax if you switch from a Vanguard mutual fund to its corresponding ETF.
But it is a one way ticket -- you can't convert from ETF back to the mutual fund version.
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Re: tax consequences of converting Vanguard MFs to ETFs

Post by jhfenton » Fri Jan 12, 2018 9:32 am

onourway wrote:
Fri Jan 12, 2018 8:56 am
Vanguard ETF's and Mutual Funds have the same tax efficiency because the ETF is simply a share class of the mutual fund. Vanguard has a patent on this method, so it is proprietary for now.
Yep. https://www.google.com/patents/US6879964
onourway wrote:
Fri Jan 12, 2018 8:56 am
Even if this were not the case, I would be hard-pressed to believe it would be worth paying capital gains in order to switch between two already very tax efficient funds.
The conversion process from mutual fund to ETF is not a taxable event.

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Re: tax consequences of converting Vanguard MFs to ETFs

Post by livesoft » Fri Jan 12, 2018 9:37 am

jhfenton wrote:
Fri Jan 12, 2018 9:32 am
The conversion process from mutual fund to ETF is not a taxable event.
There are exceptions. For instance, VBTLX cannot be "converted" to BND except by selling and re-buying, so selling is a taxable event if there is a realized gain. Check with Vanguard for all the rules and exceptions.
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Re: tax consequences of converting Vanguard MFs to ETFs

Post by triceratop » Fri Jan 12, 2018 9:41 am

Be aware that while it is not a taxable event to convert Vanguard MFs to ETFs, that does not mean it is not an event which does not have consequences in a taxable account. By that I mean that Vanguard very often screws up cost basis information during these conversions, because, well, Vanguard. It can take weeks or more to fix. I would make sure to save all my cost basis information before initiating any conversion.
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Re: tax consequences of converting Vanguard MFs to ETFs

Post by bloom2708 » Fri Jan 12, 2018 9:45 am

This seems to be a "Don't just do something, stand there" scenario.

For buy/hold investors, the mutual fund versions work great. No reason to switch.
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Re: tax consequences of converting Vanguard MFs to ETFs

Post by jhfenton » Fri Jan 12, 2018 9:46 am

livesoft wrote:
Fri Jan 12, 2018 9:37 am
jhfenton wrote:
Fri Jan 12, 2018 9:32 am
The conversion process from mutual fund to ETF is not a taxable event.
There are exceptions. For instance, VBTLX cannot be "converted" to BND except by selling and re-buying, so selling is a taxable event if there is a realized gain. Check with Vanguard for all the rules and exceptions.
Yes. Not all funds can be converted to ETFs. But selling and buying is not "converting."

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Re: tax consequences of converting Vanguard MFs to ETFs

Post by iceport » Fri Jan 12, 2018 11:25 am

bloom2708 wrote:
Fri Jan 12, 2018 9:45 am
This seems to be a "Don't just do something, stand there" scenario.

For buy/hold investors, the mutual fund versions work great. No reason to switch.
Right. And as indexfundfan noted, conversion from a Vanguard mutual fund to its ETF twin is a choice that cannot be undone without realizing any capital gains. There's really no benefit.
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Re: tax consequences of converting Vanguard MFs to ETFs

Post by triceratop » Fri Jan 12, 2018 11:39 am

There is a benefit if one holds Vanguard MFs at Vanguard and wants to use a halfway-decent brokerage. Or, if one wants to TGH while keeping the same funds. Otherwise, I agree there is little benefit.
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Re: tax consequences of converting Vanguard MFs to ETFs

Post by indexfundfan » Fri Jan 12, 2018 11:49 am

triceratop wrote:
Fri Jan 12, 2018 11:39 am
There is a benefit if one holds Vanguard MFs at Vanguard and wants to use a halfway-decent brokerage. Or, if one wants to TGH while keeping the same funds. Otherwise, I agree there is little benefit.
One other benefit: you can easily transfer ETFs among brokerages and earn their asset transfer bonuses. :-)
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Re: tax consequences of converting Vanguard MFs to ETFs

Post by triceratop » Fri Jan 12, 2018 11:51 am

indexfundfan wrote:
Fri Jan 12, 2018 11:49 am
triceratop wrote:
Fri Jan 12, 2018 11:39 am
There is a benefit if one holds Vanguard MFs at Vanguard and wants to use a halfway-decent brokerage. Or, if one wants to TGH while keeping the same funds. Otherwise, I agree there is little benefit.
One other benefit: you can easily transfer ETFs among brokerages and earn their asset transfer bonuses. :-)
Sssh, I didn't want to wake those who will immediately suggest I am being snookered and the brokerage will make all that money back off of me.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

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Re: tax consequences of converting Vanguard MFs to ETFs

Post by Earl Lemongrab » Fri Jan 12, 2018 7:37 pm

triceratop wrote:
Fri Jan 12, 2018 11:51 am
indexfundfan wrote:
Fri Jan 12, 2018 11:49 am
One other benefit: you can easily transfer ETFs among brokerages and earn their asset transfer bonuses. :-)
Sssh, I didn't want to wake those who will immediately suggest I am being snookered and the brokerage will make all that money back off of me.
It's going to be quite a whammy when they come for me.
This week's fortune cookie: "Your financial life will be secure and beneficial." So I got that going for me, which is nice.

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