Capital gains vs Return after taxes and sale of fund shares

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frugaltigris
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Joined: Fri Sep 01, 2017 8:44 am

Capital gains vs Return after taxes and sale of fund shares

Post by frugaltigris »

Hi Folks,

I am confused with tax efficiency of non-Vanguard index funds. I understand that due to patent, Vanguard index funds do not distribute capital gains and as a result they are more tax efficient. But what I am confused about is the Return after taxes and sales of all fund shares. If I look at the latter numbers, it seems that sometimes Vanguard funds can given lower net returns. I also understand that Return after taxes and sale of all fund shares makes assumptions about tax bracket and ignore personal tax situations which may vary. Let us assume that one is not gifting shares to charity etc., but one is interested in eventually cashing out the gains down the line.

The broader question I have is whether one should merely consider capital gains in considering which index funds to choose -- whether Vanguard or non-Vanguard?

(This discussion came up few weeks back on Ishares ETFs vs Fidelity index funds, see viewtopic.php?f=2&t=291540
I thank Ferdinand2014 for insights)

Here are two examples:

1. Fidelity Total US market (FSKAX) vs Vanguard Total US market (VTSAX)

It is well known on this board that FSKAX gives a lot of cap gains and is seemingly tax -inefficient compared to VTSAX. But if one sees return after taxes and sale of all shares then for 10 year period: FSKAX gives 10.86% vs VTSAX giving 10.89%. Difference is just 0.03%. For 5 year period, numbers are 8.13% (FSKAX) vs 8.17% (VTSAX), i.e. difference is 0.04%.

These numbers can be easily checked at https://fundresearch.fidelity.com/mutua ... /315911693 and https://investor.vanguard.com/mutual-fu ... ance/vtsax

Above numbers are computed for highest tax bracket but I presume for lower tax bracket the difference would be even smaller.

In contrast, for my tax bracket (22% + 6% state), the tax drag due to Fidelity fund distributing cap gains is 0.4% for 2018 and 0.2% for 2017.

Vanguard index fund wins heavily if we consider only cap gains, but narrowly if we consider Return after taxes and sale of all shares.



2. Fidelity large growth (FSPGX) vs Vanguard large growth (VIGAX)

Fidelity fund has given few cap gains in last few years, and when I compared the tax drag for my tax bracket (22% + 6% state), the difference was only 0.1% for 2018 as well as 2017.

Long term data for FSPGX is not available, but for last 3 years FSPGX had 3.68% return after taxes and sale of all shares. Whereas VIGAX had a return of 3.35%!!! I am surprised that even after cap gains distribution, FSPGX gave a much better return than VIGAX.

Links are here: https://investor.vanguard.com/mutual-fu ... ance/vigax
https://fundresearch.fidelity.com/mutua ... e=o-NavBar


Thus, I see a significant difference in computation of tax drag based on cap gains vs return after tax and sale of entire shares.

I am not sure what am I missing. I am just surprised that a Fidelity index fund has a greater after tax return and complete sale of shares than a Vanguard index fund.

Moreover, the difference in basis points is really small for VTSAX and FSKAX when computing after tax return and complete sale of shares.

Does it mean that the difference in tax efficiency for above funds becomes very small if one is interested in the picture after completing all sale of shares?

Thanks in advance for all insights.
livesoft
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Re: Capital gains vs Return after taxes and sale of fund shares

Post by livesoft »

frugaltigris wrote: Sun Oct 20, 2019 11:53 am... It is well known on this board that FSKAX gives a lot of cap gains ...
Well, I don't think "FSKAX gives a lot of cap gains" because to me "a lot" is much much more than the actual sub-0.5% amount given by FSKAX in 2018.

What I've found at bogleheads.org is that people repeat things without looking at the actual facts.
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Topic Author
frugaltigris
Posts: 92
Joined: Fri Sep 01, 2017 8:44 am

Re: Capital gains vs Return after taxes and sale of fund shares

Post by frugaltigris »

Thanks for your reply. I agree and share your sentiment. That is why I posted above numbers which seem to show that tax-inefficiency of Fidelity index funds is not as bad as I often read here, especially if one is interested in cashing out these funds eventually. In some situations they seem to be better than Vanguard index funds.
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grabiner
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Re: Capital gains vs Return after taxes and sale of fund shares

Post by grabiner »

The benefit from deferring capital gains is greater the longer you can defer them. Thus, there isn't that much difference between the five-year or ten-year returns, including the tax on sale, for funds which do and don't distribute long-term gains. (Short-term gains are still more costly, because they cause gains to be taxed at a higher rate.)

But many taxable investors will hold shares for 30 years or more before selling, and will never sell many of the shares, either donating them to charity or leaving them to heirs with a stepped-up basis. This greatly reduces the cost of unrealized capital gains.
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