How Capital Gains efficient are Vanguard ETfs vs Ishares?

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dbonnett
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How Capital Gains efficient are Vanguard ETfs vs Ishares?

Post by dbonnett »

Is it better to pay a higher ER for greater efficiency in a taxable account?
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ddb
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Post by ddb »

If you think you can predict relative tax-efficiency between two very similar index funds, then more power to you. But yes, if you have reason to believe that a particular ETF will be more tax-efficient than another, it may be worthwhile to pay a slightly higher expense ratio. Again, though, not sure how you could ever arrive at that conclusion.

I'd vote for sticking with lower costs, all else being equal.

- DDB
"We have to encourage a return to traditional moral values. Most importantly, we have to promote general social concern, and less materialism in young people." - PB
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dbonnett
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Post by dbonnett »

Where taxes are involved, the rules of reason do not apply.
ziggy29
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Post by ziggy29 »

Another thing to consider (in addition to expense ratios and tax efficiency) is the typical volume and typical bid/ask spread.

All else being relatively equal, I'd rather be in a much more liquid ETF with a 2¢ bid/ask spread per share than a thinly-traded one with a 20¢ bid/ask spread.
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ddb
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Post by ddb »

dbonnett wrote:Where taxes are involved, the rules of reason do not apply.
Yeah, but how are you going to predict future tax-efficiency? Let's look at the Vanguard Total Stock ETF (NYSE: VTI) and the iShares Dow Jones US Index ETF (NYSE: IYY). These funds are pretty much identical, except that the Vanguard fund costs less than half as much. I would not think that either fund would be more likely to distribute capital gains compared to the other, so I'd just pick the lower-cost fund.

- DDB
"We have to encourage a return to traditional moral values. Most importantly, we have to promote general social concern, and less materialism in young people." - PB
PatrickS
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Post by PatrickS »

Wasn't there something fundamentally different about the VG Vipers from other ETFs in high redemption periods that made them more susceptible to capital gains distribution? If I remember correctly, someone argued that they may be less tax-efficient than other ETFs because they are all tied to the underlying mutual fund versus other ETFs that are simply based on an index and not offered as a different share class of a mutual fund.

I don't remember if there was any detail provided in the argument, or even who brought it up. Maybe Rick Ferri can add to this thread with his thoughts.
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foodnerd
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Post by foodnerd »

I thought that Rick Ferri said in his "All about Index Investing" that Vanguards ETF shares are patented structures in which the ETF's are a underlying share of the mutual fund which allows the mutual fund to swap stocks back and forth with the ETF. Then the ETF can sell those shares and minimize capital gains.

I need to go back and find the section, but if anyone remembers where Rick states that, they can beat me to the punch. I haven't had a chance yet to read the ETF book yet.

FN
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dmcmahon
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Post by dmcmahon »

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dbonnett
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Post by dbonnett »

That nailed it...but only history can tell
billern
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Post by billern »

ddb wrote:
dbonnett wrote:Where taxes are involved, the rules of reason do not apply.
Yeah, but how are you going to predict future tax-efficiency? Let's look at the Vanguard Total Stock ETF (NYSE: VTI) and the iShares Dow Jones US Index ETF (NYSE: IYY). These funds are pretty much identical, except that the Vanguard fund costs less than half as much. I would not think that either fund would be more likely to distribute capital gains compared to the other, so I'd just pick the lower-cost fund.

- DDB
Actually, fund expenses should be a very good predictor of tax efficiency for similarly composed funds. I'm fairly certain that the funds expenses are charged against the funds taxable income for determining how much dividends and capital gains to distribute. So, the higher the expense ratio, the less income there is to distribute! Unfortunately, that does also mean lower dividends for you and me.

I'm not sure exactly how fund expenses reduce the taxable income. They may be applied pro-rata for the different types of income (ordinary dividends, qualified dividends, and capital gain distributions based on the amounts). Or they may be applied to the types of income in a different way (if you wanted the best result, you would offset ordinary income, then qualified dividends and capital gains later as those are taxed at higher rates).

here is what I think:
Say you have a ETF. It owns 1 share of stock XYZ which pays $100 of dividends in 2008 to the ETF. The ETF's expense ratio results in $5 of fees for the year. My understanding is that this leaves $95 that has to be distributed to the shareholders of the ETF during the year so that the shareholders are taxed on the $95 dividend and the ETF does not pay any income taxes.
If the ETF held the same thing but charged $10 in fees, they would have $90 of income to distribute to the shareholders who would pay tax on that lower amount.
Obviously, the first case is better than the second even with the additional taxable income. but, the second case would probably qualify as 'more tax efficient'
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