Help me understand Morningstar Tax Cost Ratio. Some things are not right?

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AndroAsc
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Help me understand Morningstar Tax Cost Ratio. Some things are not right?

Post by AndroAsc » Tue Jul 09, 2019 10:01 pm

I'm trying to figure out using a more precise method the tax efficiency of my various ETF/funds, and which one I should place in taxable.

I recently stumbled onto Morningstar Tax Cost Ratio, which they define as "The Morningstar Tax Cost Ratio measures how much a fund's annualized return is reduced by the taxes investors pay on distributions."

Has anyone done a detailed analysis into M* Tax Cost Ratio and sees if it makes sense? Some things are not adding up for me.

Here's some sample data for last 5-years tax cost ratio, and things that don't make complete sense to me:

1. Why is VEA and VWO so much higher than VTI? Both VTI and VEA are total market funds, and VWO is large-cap centric, so why are their tax costs not the same as VTI?
VTI - 0.56%
VEA - 0.91%
VWO - 0.94%

2. Why is Vanguard's Multifactor Fund almost the same (actually lower) in terms of tax efficiency as Vanguard's total market? Is it a closet total market fund?
VFMF - 0.45% (1-yr history only)
VTI - 0.63% (1-yr history only)

3. These 2 ETFs track the same S&P 600 Pure Value ETF, but they have 4X difference in tax efficiency. I know Paul Merriman recommends IJS in taxable... but how is this possible? How is it that IJS is even MORE tax efficient than VTI?
SLYV - 1.68%
IJS - 0.42%

4. VEU and VSS track the same international market, but why is the difference between VEU (large-cap) vs VSS (small-cap) so small? Isn't small cap supposed to be inefficient tax wise? Comparing to other small-cap international funds it looks like VSS tax cost ratio is "correct" and VEU looks too be too high (like how VWO and VEA have a higher than expected tax cost ratio).
VEU - 0.88%
VSS - 0.97%
EWX - 1.07%
DLS - 1.01%

5. The REIT funds have the highest tax cost ratio, which makes sense. But notice how the international version is not much higher than the domestic version, whereas my previous comparisons showed a big gap between US vs foreign ETFs. Why?
VNQ - 1.44%
VNQI - 1.59%

drk
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Re: Help me understand Morningstar Tax Cost Ratio

Post by drk » Tue Jul 09, 2019 10:02 pm

It’s useless. Search the forum for triceratop’s tax efficiency threads for a far better approach, with spreadsheets.

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AndroAsc
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Re: Help me understand Morningstar Tax Cost Ratio

Post by AndroAsc » Tue Jul 09, 2019 10:04 pm

drk wrote:
Tue Jul 09, 2019 10:02 pm
It’s useless. Search the forum for triceratop’s tax efficiency threads for a far better approach, with spreadsheets.
Why is it useless? I've seen some of triceratop's tax efficiency spreadsheets, but I'm also looking into several non-Vanguard ETFs. Also M* is nice because they give the past 5-yr/10-yr tax efficiency (assuming their numbers can be trusted!)

drk
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Re: Help me understand Morningstar Tax Cost Ratio

Post by drk » Tue Jul 09, 2019 10:11 pm

AndroAsc wrote:
Tue Jul 09, 2019 10:04 pm
Why is it useless? I've seen some of triceratop's tax efficiency spreadsheets, but I'm also looking into several non-Vanguard ETFs. Also M* is nice because they give the past 5-yr/10-yr tax efficiency (assuming their numbers can be trusted!)
It assumes the highest federal marginal rate, no state taxes, and that qualified dividends don’t exist.

If you fork triceratop’s sheet, it’s easy enough to non-VG ETFs. My version has iShares, State Street, and Schwab covered. Granted, it doesn’t cover the averages you’re seeking.

Topic Author
AndroAsc
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Re: Help me understand Morningstar Tax Cost Ratio

Post by AndroAsc » Tue Jul 09, 2019 10:20 pm

drk wrote:
Tue Jul 09, 2019 10:11 pm
AndroAsc wrote:
Tue Jul 09, 2019 10:04 pm
Why is it useless? I've seen some of triceratop's tax efficiency spreadsheets, but I'm also looking into several non-Vanguard ETFs. Also M* is nice because they give the past 5-yr/10-yr tax efficiency (assuming their numbers can be trusted!)
It assumes the highest federal marginal rate, no state taxes, and that qualified dividends don’t exist.

If you fork triceratop’s sheet, it’s easy enough to non-VG ETFs. My version has iShares, State Street, and Schwab covered. Granted, it doesn’t cover the averages you’re seeking.
I can see that DIY will give you more useful numbers for your personal situation (and that requires some work/effort), but all I need is an accurate *relative* ranking. Changing tax brackets should not change the relative tax efficiency between various ETFs.

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AndroAsc
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Re: Help me understand Morningstar Tax Cost Ratio. Some things are not right?

Post by AndroAsc » Tue Jul 09, 2019 10:37 pm

Ok, bringing in triceratop's data from 2017 spreadsheet, assuming 35% federal tax, 0% state tax and 15% QDI tax rate. I'm not sure if M* accounts for foreign tax credit, so I've also included with no foreign tax credit

M* (5-yr) vs Triceratop 2017 (1-yr)
IJS - 0.42% vs 0.27%
VTI - 0.56% vs 0.33%
VEA - 0.91% vs 0.55% (0.71%)
VWO - 0.94% vs 0.53% (0.75%)
VEU - 0.88% vs 0.50% (0.68%)
VSS - 0.97% vs 0.80% (0.95%)
DLS - 1.01% vs 0.42% (0.66%)

M* ranking would be:
IJS > VTI > VEU = VEA = VWO = VSS = DLS

Triceratop 2017 ranking would be:
IJS > VTI > DLS > VEU = VEA = VWO > VSS

Triceratop 2017 ranking with no foreign tax credit would be:
IJS > VTI > DLS = VEU = VEA = VWO > VSS

It does looks like Triceratop ranking without foreign tax credit is somewhat similar to M*, however to be sure, we would need like 5-yrs worth of data.

Paradoxically, IJS (small-cap) is really more efficient than VTI (total market)???

It also appears that VEA/VEU/VWO are more expensive than VTI regardless of methodology despite the fact that they are total market funds like VTI.

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grabiner
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Re: Help me understand Morningstar Tax Cost Ratio. Some things are not right?

Post by grabiner » Wed Jul 10, 2019 10:11 pm

AndroAsc wrote:
Tue Jul 09, 2019 10:01 pm
I'm trying to figure out using a more precise method the tax efficiency of my various ETF/funds, and which one I should place in taxable.

I recently stumbled onto Morningstar Tax Cost Ratio, which they define as "The Morningstar Tax Cost Ratio measures how much a fund's annualized return is reduced by the taxes investors pay on distributions."

Has anyone done a detailed analysis into M* Tax Cost Ratio and sees if it makes sense? Some things are not adding up for me.
The most important real issue is that M*'s numbers (and Vanguard's own numbers, for that matter) assume the highest federal tax rate (currently 37%, 20% on qualified dividends; Net Investment Income tax is not included) and no state tax. If you compare funds with the same type of distributions, this may not matter much, but if you are in a moderate tax bracket in a high-tax state, you pay a lower tax on non-qualified dividends and a higher tax on qualified dividends than M* assumes, which means that M*'s numbers will make bond funds look less tax-efficient and stock funds more tax-efficient.

The most important technical issue is that M* doesn't always know about qualified dividends; you can sometimes see this when there is a difference between the tax costs of Admiral and ETF shares of the same Vanguard funds.

It also appears that M* doesn't include the foreign tax credit for the international funds.
Wiki David Grabiner

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