Capital Gains est. -- Vanguard Target Retirement Funds

[Gatewood]

Vanguard recently posted their preliminary year-end distribution schedule. I was disappointed to see that Vanguard Target Retirement 2040 (VFORX) Total per-share capital gain estimate of $7.63 (14.98%). In most cases the Target Funds have % of NAV exceeding 12%.

My questions is -- does anyone have any idea how these funds can have such a high capital gains estimates. The portfolio is invested in passive index equity and bond funds. Additionally, the Institutional Target Retirement Funds have a cap gains estimate of less than .5% -- I assume they have a very similar portfolio

I called Vanguard to get some insight but their customer service was less than helpful

Appreciate any wise counsel out there for insights

Thanks in advance

Gatewood

[livesoft]

Did you notice that US equities are UP more than 40% over the past 12 months? Did you notice that bonds are down slightly? Do you think the Target Retirement funds needed to sell equities and buy bonds in order to maintain their desired asset allocation when rebalancing?

[terran]

I would assume they have to buy/sell the component index funds regularly to maintain the target asset allocation. This is probably worse when there's high volatility and when inflows into the fund are lower since they can't use the inflows to rebalance and vice versa (less volatility and higher inflows would mean lower realized capital gains). This is why it's generally not recommended to buy a target date fund in a taxable account.

[pizzy]

Did you notice that US equities are UP more than 40% over the past 12 months? Did you notice that bonds are down slightly? Do you think the Target Retirement funds needed to sell equities and buy bonds in order to maintain their desired asset allocation when rebalancing?

To add, I would assume institutional gets a much larger cash inflow and is able to rebalance without selling.

[mr_brightside]

do you hold these in a taxable account?

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[cas]

Do you hold it in a taxable account? If you hold it in a tax-deferred account, the distribution doesn't matter.

However, seems I have seen more people who are asking for portfolio reviews who are thinking of putting target date funds in a taxable account for simplicity. So maybe you do own it in a taxable account.

In any case ... Fidelity target date funds did something similar for the 2019 tax year. It was possible to figure out what had happened by digging through the most recent annual/semi-annual report. The cause turned out to be something different than most people in that thread initially guessed: Why fidelity mutual funds such as [Fidelity Freedom® Index 2050 Fund ] declined more than 10% today?

[dbr]

Do you hold it in a taxable account? If you hold it in a tax-deferred account, the distribution doesn't matter.

However, seems I have seen more people who are asking for portfolio reviews who are thinking of putting target date funds in a taxable account for simplicity. So maybe you do own it in a taxable account.

In any case not only is a TD fund likely to be not tax efficient, it can be that over time enough unrealized gain accumulates that you can't change your investment except at high tax cost -- in taxable accounts.

Owning TD funds is more complicated with implications for the investor than holding individual stock and bond funds and should be embarked upon with care except in the simplest cases where getting automatic rebalancing is worth the other issues.

[MrJedi]

Selling activity due to rebalancing. That's why these are generally not advised in a taxable account.

[mr_brightside]

certainly understand the concept of re-balancing inherent to these investments

but one thing I thought was odd is the extreme difference in the 'classes'

take the 2035 TDF

the Institutional is declaring .53%

the 'investor class' is declaring 14%

that's a huge difference I can't figure out (mine is in a tax-deferred account so it doesn't really matter -- I'm just perplexed)

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[cas]

Looking at the annual report (9/30/2020) and semi-annual report (3/31/2021)...

(Disclaimer: Everything is hazy, since the most recent available report is from 3/31/2021, which leaves the financial events in the most recent 6+ months unknown.)

Summary: Cause seems very roughly about 2/3rds from needing to meet net redemptions and 1/3rd from rebalancing.
Unknown why net redemptions (from a 2040 target date fund) were so large compared to previous years.

Long version, showing work:

1. A lot more people were selling their shares than were buying new shares, so they had to sell assets (mostly stocks) to meet redemptions. This was a big change from the previous year.

-For the year ending 9/30/2020, they had $1.1 billion more coming in from new purchases than they had going out due to redemptions.
-For the 6 months ending 3/31/2021, they had $2.4 billion more going out due to redemptions than they had coming in due to new purchases.

(Source: "Statement of Changes in Net Assets" for the 2040 fund in the relevant report.)

Why? I don't know. Various changes in people's investing behavior have been reported during the pandemic, but I don't know if any of that or something else entirely caused the switch to net redemptions in a target date fund.

People have noted that the institutional target date funds do not have the large cap gain distributions. Is the institutional version perhaps not a share class of the "regular" version? (I didn't look it up.) If so, were companies perhaps shifting from "regular" to "institutional" within their 401(k)s, causing net redemptions in the "regular" target date fund?

2. Rebalancing, although in the 6 months that can be seen in the report the rebalancing seems to be less of a factor than the net redemptions.

-For the year ending 9/30/2020, they sold 3.9 billion of assets (very roughly half stocks and half bonds) for a realized cap gain of 41 million.
-For the 6 months ending 3/31/2020, they sold 4.0 billion of assets (mostly stocks) for a realized cap gain of 1.1 billion. (***1.1 billion vs 41 million is a big flashing light, as far as cap gain distributions***)

-For the year ending 9/30/2020, they bought 4.7 billion worth of assets (very roughly half stocks and half bonds). (Larger than the 3.9 billion they sold, presumably because of the net purchases of shares that year.)
For the 6 months ending 3/31/2021, they bought 1.2 billion of assets (mostly bonds). (This is much smaller than the 4.0 billion they sold, presumably because of the 2.4 billion of net redemptions they had to meet. Note that 2.4 billion in net redemptions is about double the 1.2 billion in rebalancing.)

Source: relevant report for 2040 fund for the time period, "Notes to Financial Statements" -> Item F "Transactions during the period in affiliated underlying Vanguard funds"

[cas]

People have noted that the institutional target date funds do not have the large cap gain distributions. Is the institutional version perhaps not a share class of the "regular" version? (I didn't look it up.) If so, were companies perhaps shifting from "regular" to "institutional" within their 401(k)s, causing net redemptions in the "regular" target date fund?

Hmm ... perhaps this?

December 11, 2020 news release: "Vanguard Broadens Access to Low-Cost Institutional Target-Date Funds"

Vanguard is continuing to lower the cost of investing by broadening access to Vanguard Institutional Target Retirement Funds (TRFs). Effective immediately, the plan-level minimum investment requirement has been reduced to $5 million from $100 million, enabling more 401(k) and 403(b) plan sponsors to offer these low-cost, broadly diversified options to their retirement plan participants.

[cas]

Also this. Someone would have to do more research on which underlying funds get sold and which get bought to figure out what cap gain distribution consequences might be.

VALLEY FORGE, PA (September 28, 2021)—Vanguard today announced [. . . it] will consolidate its lineup with the planned mergers of Vanguard Institutional Target Retirement Funds into Vanguard Target Retirement Funds (TRFs) [. . .] The TRF mergers are expected to be completed in February 2022.

[sycamore]

Side note: there was some discussion of this topic over in viewtopic.php?f=10&t=362445.

[Gatewood]

I want to thank everyone for their thoughtful replies. Unfortunately, I hold the fund in a non-qualified account that I purchased 15 years ago.

Live and learn

Thanks again

[informal guide]

My view is that it is likely that Corporate Plan sponsors moved from the Vanguard target date retirement funds to the lower cost Target Retirement Trusts or to other non-Vanguard target date funds.(the Vanguard target retirement trusts have even lower expenses and are a different legal structure (collective investment trusts, not mutual funds) and not share classes of the funds). If this happens, it is likely large one-time transactions, much bigger than daily cash flows. If this were the case, the underlying fund assets in the funds - Total Stock, Total Bond, etc.) would be sold, creating capital gains, unless incoming plan level transactions could be scheduled on the same day..

It is likely Vanguard manages the target retirement funds for total return (to meet or slightly beat the benchmarks), rather than for tax efficiency, given that the vast majority of the fund assets are held in tax-deferred accounts.

[Quaestner]

Unfortunately, I hold the fund in a non-qualified account

If you haven’t yet, maybe turn off dividend reinvestment so you can reallocate that income to a more tax efficient investment?

[Django Ii]

[Thread merged into here --admin LadyGeek]

Although I own Target Date Income in my Rollover IRA so will not be subject to taxes, I'm curious to why there are 3 to 4 times the amount of capital gains being distributed this year compared to last year. Any thoughts?

[sport]

The bond funds may have CG distributions this year. That does not always happen.

[sycamore]

There's some discussion of this in a couple places.

viewtopic.php?p=6336873#p6336873
viewtopic.php?p=6332137#p6332137

Summary is that there are multiple reasons:

- more redemptions of the fund than purchases

- the fund did some rebalancing, because 1) stocks had more of an up year than bonds and 2) needing to follow the glide path where the fund's stock allocation slowly drops each year

- Vanguard is swapping out one version of the Total International Bond Index fund for another

- Vanguard is merging the Institutional version of the Target funds with their Investor share class versions

The last two are being done to lower expenses.

[Django Ii]

Thanks for the replies. All great answers. I wasn't aware of the big changes...my bad for taking "set and forget" a bit too literally.

[drumboy256]

One question I have (in general) about this happening is do the fixed asset allocation mutual funds / ETFs avoid this issue all together because there is no glide path + they are structured "better" (whatever that means). It seems like Vanguard and/or BlackRock could play more shell games fixed asset allocation than they could with TDF but that seems anecdotal at best.

[sycamore]

One question I have (in general) about this happening is do the fixed asset allocation mutual funds / ETFs avoid this issue all together because there is no glide path + they are structured "better" (whatever that means). It seems like Vanguard and/or BlackRock could play more shell games fixed asset allocation than they could with TDF but that seems anecdotal at best.

You're right they don't have to deal with a declining glide path, but they still have to deal with rebalancing to stick to their target AA. If stocks are way up one year, they'll sell stocks to rebalance into bonds. The sales will cause cap gains. With an ETF I believe those cap gains could be avoided (or off-loaded).

Another thing LifeStrategy as a mutual fund can't avoid -- if investors sell more than buy then fund, the fund has to sell some of its underlying holdings to raise cash for the redemptions. Those sales also result in cap gains for the remaining shareholders.

Another potential thing causing higher cap gains is Vanguard switching the LifeStrategy funds out of the "Total International Bond Index Fund
Vanguard Total International Bond II Index Fund" and into the newer "Total International Bond II Index Fund". That's presumably a once-in-a-lifetime switch.

[sa5]

Ugh, I also hold a Vanguard Target Retirement Fund in a taxable account I knew this was not optimal, but this capital gain is way higher than in the previous 10 years!

I'll stop contributing to the Vanguard Target Retirement Fund. Is there any preference for going with the underlying mutual funds or ETFs (e.g VTSAX vs VTI)? Can you auto-invest with ETFs? One pro I see to the ETFs is that they could be moved out of Vanguard and sold with no-fee if I decided to take my business elsewhere.

[sycamore]

Is there any preference for going with the underlying mutual funds or ETFs (e.g VTSAX vs VTI)?

It's up to you. Performance-wise, no difference if we're talking about Vanguard mutual funds and their related ETFs.
For other considerations, see the wiki article https://www.bogleheads.org/wiki/ETFs_vs_mutual_funds

Can you auto-invest with ETFs?

Not at Vanguard brokerage. I don't know of any brokerage that offers it. Some (like Fidelity) offer fractional share ETF investing which allows for purchasing in dollar amounts rather than share amounts. This is a pre-req for auto-investing, so maybe soon we'll get ETF auto-investing.

[drumboy256]

One question I have (in general) about this happening is do the fixed asset allocation mutual funds / ETFs avoid this issue all together because there is no glide path + they are structured "better" (whatever that means). It seems like Vanguard and/or BlackRock could play more shell games fixed asset allocation than they could with TDF but that seems anecdotal at best.

You're right they don't have to deal with a declining glide path, but they still have to deal with rebalancing to stick to their target AA. If stocks are way up one year, they'll sell stocks to rebalance into bonds. The sales will cause cap gains. With an ETF I believe those cap gains could be avoided (or off-loaded).

Another thing LifeStrategy as a mutual fund can't avoid -- if investors sell more than buy then fund, the fund has to sell some of its underlying holdings to raise cash for the redemptions. Those sales also result in cap gains for the remaining shareholders.

Another potential thing causing higher cap gains is Vanguard switching the LifeStrategy funds out of the "Total International Bond Index Fund
Vanguard Total International Bond II Index Fund" and into the newer "Total International Bond II Index Fund". That's presumably a once-in-a-lifetime switch.

Yeah good point. I’m guessing the fund switch will be infrequent since it does cause issues like we’ve just seen.

[Hyperchicken]

OP tried to warn us. We did not listen.

[segfault]

Thanks! When I did my Quicken download this evening, I said "what" so many times that Macklemore took me thrift shopping!

[LadyGeek]

I merged Django Ii's thread into a similar discussion.

[diamonds_in_the_sky]

I personally got lucky with this given that I never tried target retirement funds in taxable, but I'm curious how likely is this to happen with other funds, such as VTI + VXUS?

I was reading sycamore's answer, and especially this bullet point bothered me:

- more redemptions of the fund than purchases

Could this mean that after 15-20 years of investing into VTI, I could run into a problem where people start liquidating their VTI, and I keep getting larger dividend payments than normal, but I can't do anything about my position for tax reasons because presumably at that point it's more than 300% up?

If this scenario is plausible, how do people defend against that?

[02nz]

Could this mean that after 15-20 years of investing into VTI, I could run into a problem where people start liquidating their VTI, and I keep getting larger dividend payments than normal, but I can't do anything about my position for tax reasons because presumably at that point it's more than 300% up?

Vanguard's stock index ETFs - or for that matter any stock index ETFs I know of - generally do not have capital gains distributions, because of the way ETFs work. (Vanguard's patented share class structure also allows its stock index mutual funds with an ETF equivalent, such as VTSAX, to enjoy the same advantage.) As for dividend distributions, those are unavoidable and depend only on dividends paid out by the underlying stocks. Dividend distributions are never affected by liquidations of the ETF.

[000]

Vanguard's stock index ETFs - or for that matter any stock index ETFs I know of - generally do not have capital gains distributions, because of the way ETFs work. As for dividend distributions, those are unavoidable and depend only on dividends paid out by the underlying stocks. Dividend distributions are never affected by liquidations of the ETF.

There is a concern however that because Vanguard's stock ETFs like VTI are a share class of the same fund with mutual fund share classes that large redemptions from the MF shares could bleed into cap gain distributions for all share classes.

Vanguard could also change the index tracked in a non-efficient way, like happened recently with VIGI.

[VTI]

Could this mean that after 15-20 years of investing into VTI, I could run into a problem where people start liquidating their VTI, and I keep getting larger dividend payments than normal, but I can't do anything about my position for tax reasons because presumably at that point it's more than 300% up?

Vanguard's stock index ETFs - or for that matter any stock index ETFs I know of - generally do not have capital gains distributions, because of the way ETFs work. As for dividend distributions, those are unavoidable and depend only on dividends paid out by the underlying stocks. Dividend distributions are never affected by liquidations of the ETF.

What if someone owns a boring, vanilla index mutual fund, say Fidelity 500 Index Fund or Vanguard 500 Index Fund.

If there are a lot of redemptions, are the owners at risk for gargantuan distributions, or are simple index funds managed differently? Has this ever happened to an index mutual fund?

EDIT: According to Morningstar, the Vanguard Total Stock Market Index Fund has unrealized capital gains of 50%! Is that a timebomb?

[02nz]

I think this Morningstar article addresses the concerns raised above: https://www.morningstar.com/articles/96 ... -tax-risks

[S_Track]

Could this mean that after 15-20 years of investing into VTI, I could run into a problem where people start liquidating their VTI, and I keep getting larger dividend payments than normal, but I can't do anything about my position for tax reasons because presumably at that point it's more than 300% up?

Vanguard's stock index ETFs - or for that matter any stock index ETFs I know of - generally do not have capital gains distributions, because of the way ETFs work. As for dividend distributions, those are unavoidable and depend only on dividends paid out by the underlying stocks. Dividend distributions are never affected by liquidations of the ETF.

What if someone owns a boring, vanilla index mutual fund, say Fidelity 500 Index Fund or Vanguard 500 Index Fund.

If there are a lot of redemptions, are the owners at risk for gargantuan distributions, or are simple index funds managed differently? Has this ever happened to an index mutual fund?

EDIT: According to Morningstar, the Vanguard Total Stock Market Index Fund has unrealized capital gains of 50%! Is that a timebomb?

VG target date funds hold total stock and total international. What if VG decided to replace those 2 with Total World? Considering the size of the target date funds, that would be one possibility for a large number of redemptions to total stock and total international. Although I would imagine if they did such a change, it would occur slowly.

[Bmac]

I’ve received both ST and LT capital gains from two tax exempt bond funds this year, which I don’t recall ever happening before.

[LadyGeek]

^^^ Remember that tax-free bonds, e.g. municipal bonds, are only tax-free on the interest. Capital gains are taxable.

See: Tax implications of bonds and bond funds, from Fidelity

[Bmac]

Yes. I’m aware of that. I’m just pointing out that the capital gains issues being discussed are not limited to the Target Date funds or even equity funds. Previously I’ve only had capital gains from any of our Vanguard mutual funds due to actual buying and selling (with the exception of some minor capital gains distributions). I’m not complaining but it is interesting.

[sa5]

I think I'm screwed by Vanguard resulting in an enormous tax bill. I couldn't sell at a loss because the funds were acquired some time ago.

What concerns me is that this will happen again in the future. Is it possible to convert target retirement funds into the underlying funds without having to sell resulting in more capital gains? I'd call Vanguard and ask, but the wait time on hold was 4+ hours the other day

[dbr]

I think I'm screwed by Vanguard resulting in an enormous tax bill. I couldn't sell at a loss because the funds were acquired some time ago.

What concerns me is that this will happen again in the future. Is it possible to convert target retirement funds into the underlying funds without having to sell resulting in more capital gains? I'd call Vanguard and ask, but the wait time on hold was 4+ hours the other day

Once you have a tax inefficient fund in a taxable account and it has been there for some time with large unrealized appreciation, then you are stuck. But I doubt these large distributions are going to repeat every year.

Still, I wish before advising people that TR funds are a simple selection for inexperienced investors that there should be some reminders of the possible ramifications in different situations.

[sa5]

Still, I wish before advising people that TR funds are a simple selection for inexperienced investors that there should be some reminders of the possible ramifications in different situations.

Yes, lesson learned. I thought I was doing the simple thing best for inexperienced investors that allowed me to set it and forget it. I knew it was not optimal (better to hold bonds only in tax advantaged accounts and I was stuck with the glide path) but I did not expect what happened this year.

I feel that Vanguard guided me down this path which is frustrating.

[Geologist]

I’ve received both ST and LT capital gains from two tax exempt bond funds this year, which I don’t recall ever happening before.

I first bought the Intermediate Term Tax-Exempt Bond Fund in 1997. I then received capital gains (ST and LT) in 1997, 1998, 2001, and 2002. So, in those early years, I would have said that capital gains distributions were the usual case. It appears, however, that this year is the first year since. So it has been a long time, but not unprecedented.

[djwinvest]

Just chiming in to gripe about VMGRX, which distributed 27%!!! LTCG in December. I haven't seen this specific fund mentioned in these Vanguard cap gains threads. I think I am going sell my position in the fund, as my unrealized gain is now much lower! Planning to replace with VMGMX.

https://investor.vanguard.com/mutual-fu ... ions/vmgrx

[Otnot]

I'll add myself to the list of people who just learned a very big lesson today about holding target date funds in a taxable account and will have the tax bill to prove it. I am disappointed in myself that I didn't understand this risk, but fortunately most of my taxable account is not in these accounts.

I retired in November, so I am no longer contributing to these accounts. I will probably just leave them alone from here on out since I'll be taking future distributions for living expenses.

[Geoman]

I still think Target Date Funds are not horrible in a taxable account. The huge amount of long-term capital gain distributions this year has not happened for at least 10 years (it may have never been close to what it is this year). There is always a possibility that it can happen again in the future (as with probably any index or etf) but it seems unlikely.

[dbr]

I still think Target Date Funds are not horrible in a taxable account. The huge amount of long-term capital gain distributions this year has not happened for at least 10 years (it may have never been close to what it is this year). There is always a possibility that it can happen again in the future (as with probably any index or etf) but it seems unlikely.

You are right in that respect. That also means people have to stop complaining if it does happen.

[sycamore]

I still think Target Date Funds are not horrible in a taxable account. The huge amount of long-term capital gain distributions this year has not happened for at least 10 years (it may have never been close to what it is this year). There is always a possibility that it can happen again in the future (as with probably any index or etf) but it seems unlikely.

You are right in that respect. That also means people have to stop complaining if it does happen.

I have
low confidence in a prediction that there'll be huge distributions in 2022
high confidence in a prediction that there'll be complaints about it

[retiringwhen]

Just chiming in to gripe about VMGRX, which distributed 27%!!! LTCG in December. I haven't seen this specific fund mentioned in these Vanguard cap gains threads. I think I am going sell my position in the fund, as my unrealized gain is now much lower! Planning to replace with VMGMX.

https://investor.vanguard.com/mutual-fu ... ions/vmgrx

A good rule is don’t buy active funds in taxable accounts. You can assume regular large capital gains distributions

[ifish100]

I too own VTTVX in a taxable account, mistake made long ago. I noticed the very high LT capital gains distributed, very surprised by that. Fortunately I had my Gains and Dividends set to go to the Brokerage fund, so at least they did not get reinvested. I have been reinvesting them into individual classic "3 fund" funds for the last couple of years.

I have tried to reconstruct mathematically how just the act of rebalancing from about 60% stock at the beginning of the 2021, to 57% stock now even considering the high increase in the underlying mainly US stock fund could have resulted in such a huge resulting LT capital gain, in my case I am getting the amount needed to rebalance to 57% even considering the stock run up in US stock... I am getting the capital gain payout to be about 2X of the total rebalance amount, seems off. The underlying funds.... US stk +23% for year, Int stk +1.1%, US bond -3%, int bond -2%. It is true the stk went up and bonds went down (double whammy), so you have that for performance, and compounded by having to rebalance down from 60% stock to 57% for glide path reasons. If you look at the glide path it is about 60% stock at 60 to 50% stock at 65, so they are reducing the stock amount by about 2% per year from 2020 to 2025. If we consider the US stocks were up about 23% this last year, on average they are up 10%, this would imply the huge LT capital gain would be expected to be about 1/2 of what we saw this year for the next 5 years to 2025, then the glide path goes from 50% stocks to 30% stocks from 65 to 72, so 20% over a 7 year period, so about 2.85% per year, that could be an ouch. One of the other posters recommended slowly taking the dividends and capital gains and reinvesting them into the Classic 3 funds, that is what I am doing as well, once your gains get low enough you can just sell the whole balance of VTTVX, but while there is a lot of $ in there, quite painful tax wise.

Has anyone else tried to understand how such a large LT cap gain from the stock rebalance is justified?

[JJinWI]

[Thread merged into here --admin LadyGeek]

I am investing in Vanguard Retirement 2030 through my 457 account. The current balance is approximately $556,0000. My dividends posted on 12/30. They were approximately $82,000. Previous years, they were around $10,000. Anyone know why so high this time?

[Makefile]

Discussed on the forum in a few places already. Something about employers moving to CITs and selling out of the fund, or moving to institutional shares; institutional and investor shares are merging early this year. Be thankful it's in a 457 so no income tax consequences.