What's a way to determin what is tax-efficient?

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get_g0ing
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What's a way to determin what is tax-efficient?

Post by get_g0ing » Tue Oct 08, 2019 7:48 am

Hi BHs,

I have two questions if anyone cares to help educate a bit please:

1. What's a reliable way you guys use to determine whether a Fund or ETF is tax-efficient or not? Is there a standard go-to method for this?
I come across posts like fund xyz is very tax-efficient or not tax-efficient, so I'm wondering that's the criterion?

In an earlier discussion someone brought up Capital Gains, so to test that I looked up two S&P 500 funds on Morningstar:
SPY (SPDR S&P 500 ETF) - Potential Capital Gains Exposure 0%
IVV (iShares S&P 500 ETF) - Potential Capital Gains Exposure 11%

Shouldn't the percentages be much closer to each other, since both are S&P 500?
It seems like I'm not looking at the right place or not using the correct way to determine this.

2. Let's say there are two funds: Fund A had higher historic returns but is less tax-efficient than Fund B. Is there a method to determine which would have been better overall in a taxable account.
(I am not claiming this is the way to know which would be better going forward)

Thanks.

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simplesimon
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Re: What's a way to determin what is tax-efficient?

Post by simplesimon » Tue Oct 08, 2019 10:10 am

get_g0ing wrote:
Tue Oct 08, 2019 7:48 am
Hi BHs,

I have two questions if anyone cares to help educate a bit please:

1. What's a reliable way you guys use to determine whether a Fund or ETF is tax-efficient or not? Is there a standard go-to method for this?
I come across posts like fund xyz is very tax-efficient or not tax-efficient, so I'm wondering that's the criterion?

In an earlier discussion someone brought up Capital Gains, so to test that I looked up two S&P 500 funds on Morningstar:
SPY (SPDR S&P 500 ETF) - Potential Capital Gains Exposure 0%
IVV (iShares S&P 500 ETF) - Potential Capital Gains Exposure 11%

Shouldn't the percentages be much closer to each other, since both are S&P 500?
It seems like I'm not looking at the right place or not using the correct way to determine this.

2. Let's say there are two funds: Fund A had higher historic returns but is less tax-efficient than Fund B. Is there a method to determine which would have been better overall in a taxable account.
(I am not claiming this is the way to know which would be better going forward)

Thanks.
https://www.bogleheads.org/wiki/Tax-eff ... _placement

The above link may help. It comes down to how much turnover a fund has and what kind of distributions the underlying investments generate, and what proportion of total return comes from both capital gains and distributions.

Yes theoretically two different funds tracking the same index should have very similar tax efficiency. Variations can occur because of size and how the funds are administered. I honestly have not looked into it as I blindly trust Vanguard, but maybe others here have done a deeper analysis comparing index funds.

02nz
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Re: What's a way to determin what is tax-efficient?

Post by 02nz » Tue Oct 08, 2019 10:32 am

Morningstar used to have tax-adjusted returns for each fund (I believe these were calculated assuming you were in the highest federal bracket and no state tax) but I'm not seeing that information now, maybe it's a subscriber-only feature. It was one way to see the impact of tax efficiency on returns.

KlangFool
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Re: What's a way to determin what is tax-efficient?

Post by KlangFool » Tue Oct 08, 2019 10:37 am

OP,

I do not understand why you are asking this question. The ultimate determinant of tax-efficiency is the individual. Not the fund and/or ETF. You get to decide when to sell the fund/ETF and harvest the gain/loss.

So, if you have 1 year or more in the emergency fund, you have the freedom to decide when to sell. Then, how does the potential capital gain affect you?

Please correct my misunderstanding if I miss something here.

KlangFool

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BL
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Re: What's a way to determin what is tax-efficient?

Post by BL » Tue Oct 08, 2019 12:41 pm

My understanding would be to look at distributed Capital Gains (not from your selling) and dividends other than qualified dividends. Vanguard's Total Stock market Fund has not distributed CGs in the recent past, at least, and most of it's dividends are qualified; I consider that tax efficient as it minimizes taxes.

I can think of a couple active funds we had that distributed CGs regularly, so it cost more each year in taxes.

AlohaJoe
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Re: What's a way to determin what is tax-efficient?

Post by AlohaJoe » Tue Oct 08, 2019 10:44 pm

get_g0ing wrote:
Tue Oct 08, 2019 7:48 am
1. What's a reliable way you guys use to determine whether a Fund or ETF is tax-efficient or not? Is there a standard go-to method for this?
The only reliable way is to lookup all of a fund's distributions and then plug those numbers into your own personal tax return and see what happens. A lot of it depends on your personal tax situation, so all the things you see online are -- at best -- very coarse approximations. Whether you have to pay NIIT affects it. What your state tax rate is affects it. Whether you qualify for QBI deductions affects it. Your federal tax rate affects it.

I'm pretty sure that 99% of people don't reliably determine whether a fund is tax-efficient or not. They go by the common wisdom, something they read in a book once, and broad rules of thumb.

There's also not really such a thing as 100% tax-efficient or 100% tax-inefficient -- just shades of gray. Everything needs to be compared against its after-tax returns. If something is "tax-inefficient" but returns 8% a year is that better or worse than something that is "tax-efficient" but returns 7% a year?

Some fund families do a better job of providing all the information you need in one place. Vanguard is not good at it. iShares is the best. Here's their 2018 distribution summary for every fund they have: https://www.ishares.com/us/literature/t ... 716296.pdf

sandramjet
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Re: What's a way to determin what is tax-efficient?

Post by sandramjet » Tue Oct 08, 2019 11:35 pm

KlangFool wrote:
Tue Oct 08, 2019 10:37 am
OP,

I do not understand why you are asking this question. The ultimate determinant of tax-efficiency is the individual. Not the fund and/or ETF. You get to decide when to sell the fund/ETF and harvest the gain/loss.

So, if you have 1 year or more in the emergency fund, you have the freedom to decide when to sell. Then, how does the potential capital gain affect you?

Please correct my misunderstanding if I miss something here.

KlangFool
I believe that ETFs, just like mutual funds, may distribute capital gains, etc at year end. It is much much less common than in mutual funds, but it can happen.

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House Blend
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Re: What's a way to determin what is tax-efficient?

Post by House Blend » Wed Oct 09, 2019 9:35 am

AlohaJoe wrote:
Tue Oct 08, 2019 10:44 pm
Some fund families do a better job of providing all the information you need in one place. Vanguard is not good at it. iShares is the best. Here's their 2018 distribution summary for every fund they have: https://www.ishares.com/us/literature/t ... 716296.pdf
Shrug. If you want all of the tax-related information for all Vanguard funds in one place (going back several years), it's here:
https://advisors.vanguard.com/VGApp/iip ... ?year=2018

If you want it all in a spreadsheet, they've got it here:
https://advisors.vanguard.com/VGApp/iip ... e=iciFiles

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grabiner
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Re: What's a way to determin what is tax-efficient?

Post by grabiner » Thu Oct 10, 2019 9:47 pm

get_g0ing wrote:
Tue Oct 08, 2019 7:48 am
In an earlier discussion someone brought up Capital Gains, so to test that I looked up two S&P 500 funds on Morningstar:
SPY (SPDR S&P 500 ETF) - Potential Capital Gains Exposure 0%
IVV (iShares S&P 500 ETF) - Potential Capital Gains Exposure 11%

Shouldn't the percentages be much closer to each other, since both are S&P 500?
It seems like I'm not looking at the right place or not using the correct way to determine this.
This number is the potential gain: if the fund sold all its stock tomorrow, what would the capital gain be?

For an ETF, this number is not particularly relevant; if investors don't want to hold the ETF, they won't force the ETF to sell anything, as it will give away stock by in-kind redemptions.

Even for a conventional index fund, the number is not that useful, because the fund may not sell the stock. A total-market index or S&P 500 index rarely sells anything, so it won't generate much in capital gains and will accumulate a large potential exposure. A small-cap index must sell stocks which are no longer small, and will distribute a capital gain when this happens.

Most stock ETFs (and Vanguard index funds, which have the ETF as a share class) can avoid all capital gains because of the way the redemption process works.
Wiki David Grabiner

GoPackGo
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Re: What's a way to determin what is tax-efficient?

Post by GoPackGo » Thu Oct 10, 2019 9:59 pm

triceratop's tax efficiency spreadsheet is pretty useful. You would have to update the numbers yourself if you want recent data.
viewtopic.php?t=242137

Ferdinand2014
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Re: What's a way to determin what is tax-efficient?

Post by Ferdinand2014 » Fri Oct 11, 2019 2:32 am

If you are looking for relative tax efficiency for a given fund as opposed to actual tax efficiency based on your taxes just look in the prospectus or online. All funds show the return for 1,3,5,10 and/or lifetime net of fees, after taxes on distributions and after taxes on distributions and sale of fund shares. It does not take into account state taxes and assumes the highest federal tax bracket. For example:

FXAIX (Fidelity 500 index fund) as of 12/31/18
S&P500 return at 10 years. 13.12%
Return net of fees at 10 years 13.11%
Return after taxes on distributions. 12.57%
Ret. after taxes on distributions and
sale of fund shares (liquidation). 10.93%

.1093/1311 = .8337 or 83.37% you keep if you are in highest federal tax bracket, and then liquidate after 10 years while paying taxes on reinvested dividends and capital gains along the way.

Since all funds supply this information in a standard format, you can do the math yourself. As Klangfool has pointed out, your tax burden will depend mostly on you especially with a low turnover index fund.
“You only find out who is swimming naked when the tide goes out.“ — Warren Buffett

livesoft
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Re: What's a way to determin what is tax-efficient?

Post by livesoft » Fri Oct 11, 2019 10:47 am

get_g0ing wrote:
Tue Oct 08, 2019 7:48 am
1. What's a reliable way you guys use to determine whether a Fund or ETF is tax-efficient or not? Is there a standard go-to method for this?
I come across posts like fund xyz is very tax-efficient or not tax-efficient, so I'm wondering that's the criterion?
The reliable go-to method for this is for one to calculate how much income taxes they would have paid if they held an example amount (say $10,000) of the investment product in question for each of the last 5 years.
2. Let's say there are two funds: Fund A had higher historic returns but is less tax-efficient than Fund B. Is there a method to determine which would have been better overall in a taxable account.
See my answer to your first question.

BTW, the spreadsheets floating around on bogleheads.org show exactly how to do this. One only has to find the input data to fill in the spreadsheets which is relatively easy to do. The main issue appears to be that people don't want to do this themselves and don't want to pay anyone to do it for them.
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Topic Author
get_g0ing
Posts: 546
Joined: Sat Dec 09, 2017 11:09 am

Re: What's a way to determin what is tax-efficient?

Post by get_g0ing » Sat Oct 12, 2019 12:02 pm

02nz wrote:
Tue Oct 08, 2019 10:32 am
Morningstar used to have tax-adjusted returns for each fund (I believe these were calculated assuming you were in the highest federal bracket and no state tax) but I'm not seeing that information now, maybe it's a subscriber-only feature. It was one way to see the impact of tax efficiency on returns.
Another poster pointed me to Fidelity which still has that info. I now find that very useful and a little eye-opening to see the return go down by about 3% after taxes. Yikes!

Topic Author
get_g0ing
Posts: 546
Joined: Sat Dec 09, 2017 11:09 am

Re: What's a way to determin what is tax-efficient?

Post by get_g0ing » Sat Oct 12, 2019 12:46 pm

Ferdinand2014 wrote:
Fri Oct 11, 2019 2:32 am
If you are looking for relative tax efficiency for a given fund as opposed to actual tax efficiency based on your taxes just look in the prospectus or online. All funds show the return for 1,3,5,10 and/or lifetime net of fees, after taxes on distributions and after taxes on distributions and sale of fund shares. It does not take into account state taxes and assumes the highest federal tax bracket. For example:

FXAIX (Fidelity 500 index fund) as of 12/31/18
S&P500 return at 10 years. 13.12%
Return net of fees at 10 years 13.11%
Return after taxes on distributions. 12.57%
Ret. after taxes on distributions and
sale of fund shares (liquidation). 10.93%

.1093/1311 = .8337 or 83.37% you keep if you are in highest federal tax bracket, and then liquidate after 10 years while paying taxes on reinvested dividends and capital gains along the way.

Since all funds supply this information in a standard format, you can do the math yourself. As Klangfool has pointed out, your tax burden will depend mostly on you especially with a low turnover index fund.
Yes, I was looking for relative tax efficiency. Thank you.

Topic Author
get_g0ing
Posts: 546
Joined: Sat Dec 09, 2017 11:09 am

Re: What's a way to determin what is tax-efficient?

Post by get_g0ing » Sat Oct 12, 2019 12:50 pm

livesoft wrote:
Fri Oct 11, 2019 10:47 am
get_g0ing wrote:
Tue Oct 08, 2019 7:48 am
1. What's a reliable way you guys use to determine whether a Fund or ETF is tax-efficient or not? Is there a standard go-to method for this?
I come across posts like fund xyz is very tax-efficient or not tax-efficient, so I'm wondering that's the criterion?
The reliable go-to method for this is for one to calculate how much income taxes they would have paid if they held an example amount (say $10,000) of the investment product in question for each of the last 5 years.
2. Let's say there are two funds: Fund A had higher historic returns but is less tax-efficient than Fund B. Is there a method to determine which would have been better overall in a taxable account.
See my answer to your first question.

BTW, the spreadsheets floating around on bogleheads.org show exactly how to do this. One only has to find the input data to fill in the spreadsheets which is relatively easy to do. The main issue appears to be that people don't want to do this themselves and don't want to pay anyone to do it for them.
Thanks livesoft, I think I understand this somewhat now.

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