Vanguard international funds FAQ

With Vanguard currently offering several broad international index funds, some investors may wonder what they should buy in their portfolios. Here is an attempt to address frequently asked questions about these funds.

= Basic Questions =

What broad international index funds does Vanguard have?

 * Vanguard Total International Stock Index Fund
 * Vanguard FTSE All-World ex-US Index Fund
 * Vanguard Tax-Managed International Fund

Should I buy Total International or FTSE All-World ex-US?
Buy Total International in a tax-advantaged account and FTSE All-World ex-US in a taxable account.

FTSE All-World ex-US

 * Tax efficient. Its dividends were 87.23% qualified in 2007. It is eligible for foreign tax credit. It's very unlikely to distribute capital gains in the event that a country (think South Korea) moves out of emerging markets and joins developed markets.
 * The expense ratio (0.35%) is higher than that of Total International (0.28%), but that's more or less offset by foreign tax credit, which , in fiscal year 2008, was approximately 0.17%.[1]
 * Includes Canada.
 * Vanguard might introduce Admiral Shares as the fund grows. To this date, Vanguard has never issued Admiral Shares for a fund of funds, which Total International is.
 * Vanguard is expected to lower the expense ratio as the fund grows. Historically, Vanguard has been good at reducing the expense ratio as the fund grows. (For example, check out the expense ratio history of the European,  Pacific, and  Emerging Market index funds.)

Total International

 * Not as tax efficient as FTSE All-World ex-US. Its dividends are about 74.31% qualified in 2007. It is not fully eligible for foreign tax credit because a part of the fund is invested in mutual funds, and IRS says that a fund of funds is not eligible. (Don't ask!)
 * The expense ratio (0.28%) is lower than that of FTSE All-World ex-US (0.35%).
 * Does not include Canada.

What is foreign tax credit?
Foreign tax credit in our context is a refund of tax that Vanguard pays in foreign countries on dividends. When Vanguard distributes dividends, they are already reduced by tax paid in foreign countries. With foreign tax credit, you can get that amount back, but you still have to pay Federal income tax on the dividends before the foreign tax is paid. Sorry, foreign tax credit isn't free money.

I am running out of tax-advantaged room. Should I put Total Stock Market or FTSE All-World ex-US in a taxable account?
In general, you want to put FTSE All-World ex-US in a taxable account so that you can get foreign tax credit, but the difference isn't that great, so your individual situation may be different. In particular, if your 401(k) has better international funds than US funds, then you probably want to hold the international funds in your 401(k).

Should I hold FTSE All-World ex-US in a taxable account for foreign tax credit even though I haven't max out my tax-advantaged account?
No, you should fill your tax-advantaged account first with Total International. The main exception is a 401(k) or 403(b) with expenses so high that they negate the benefit of either tax-deferred growth or tax-free growth; you should only invest enough in such an account to get the maximum employer match. Another exception may be a non-deductible Traditional IRA. It may not be a good idea to place a tax-efficient stock index fund in a non-deductible Traditional IRA. See Non-deductible Traditional IRA for more information.

I have Total International in a taxable account. What should I do?
If you have loss in your Total International or a small amount of capital gains, you might consider selling it and buy FTSE All-World ex-US. Otherwise, you could direct new money, including distributions from Total International, into FTSE All-World ex-US. For simplicity, you should just stick with Total International because the difference is probably not significant enough to make up for the difference in capital gains from selling.

Wow, FTSE All-World ex-US has expense ratio of 0.35%? Should I buy VEU, the ETF share class of FTSE All-World ex-US, to save on the expenses?
If you take the ETF route, you can avoid the two-month redemption fee, but you will likely have to pay commission on the purchase and sale. In general, ETF shares may be a good choice if:


 * you already have a brokerage account which has low commissions (no more than $10 or so),
 * you are planning to invest in large lump sum(s), rather than small monthly contributions (which would incur a commission at every purchase),
 * your brokerage allows for (free) reinvestment of fund distributions, and
 * you can resist the temptation to trade the ETFs too often.

For a general discussion of whether to go ETF, see To ETF or Not to ETF.

You may also want to use a calculator at Calculate and compare costs for Vanguard ETFs and mutual funds to see if going with the ETF makes sense for you.

I have Tax-Managed International. Is that OK?
It's a great tax-efficient fund except that it does not have emerging markets or Canada.

The combination of Vanguard Tax-Managed International Fund and Vanguard Emerging Markets Stock Index Fund should work just as well as FTSE All-World ex-US. This combination is slightly cheaper and more tax efficient than FTSE All-World ex-US. Assuming a 80%/20% mix in the combo, its weighted average expense ratio is 0.19% with the weighted average QDI (Qualifying Dividend Income) ratio being about 95.72%. In contrast, the QDI estimate for FTSE All-World ex-US is 62.32% as of 08/2008 according to Qualified dividend income—2008 year-to-date estimates.

If you are planning to do tax loss harvesting,  Tax-Managed International is not friendly because of its 1% redemption fee for the first five years. You might consider its ETF share class VEA, or convert mutual fund shares to the ETF shares if you need to sell them within the first five years. You can of course consider FTSE All-World ex-US.

= Advanced Questions =

I heard that slicing and dicing boosts return. Why go broad?
See Slice and Dice International.

Both Total International and FTSE All-World ex-US appear to lack small-cap. What should I buy to fill that area?
Vanguard is scheduled to open an International Small-Cap Index Fund in the first quarter of 2009. See Vanguard FTSE All-World ex-US Small-Cap Index Fund for details.

I'd like some value tilt. What options does Vanguard provide?
You might consider Vanguard International Value Fund. If you are interested in growth tilt, consider Vanguard International Growth Fund. Both of these are actively managed funds and thus often distribute capital gains. You should consider placing them in a tax-advantaged account.

I heard enough about tax efficiency, qualified dividends, and all that. Show me some hard numbers!
Barry Barnitz has posted an excellent summary of hard numbers, including qualified divided percentage and capital gain distributions. Check out Vanguard International Index Fund Tax Attributes.

How are the international funds priced when there is always a market open and trading somewhere in the world?
Share price, also known as net asset value (NAV), is calculated each business day as of the close of regular trading on the New York Stock Exchange, generally 4 p.m., Eastern Time. This is true for both domestic and international funds.

Stocks held by a Vanguard fund are valued at their market value when reliable market quotations are readily available. The values of any foreign securities held by a fund are converted into U.S. dollars using an exchange rate obtained from an independent third party.

When reliable market quotations are not readily available, securities are priced at their fair value (the amount that the owner might reasonably expect to receive upon the sale of a security). A fund will also use fair-value pricing if the value of a security it holds has been materially affected by events occuring before the fund's pricing time but after the close of the primary markets or exchanges on which the security is traded. This most commonly occurs with foreign securities, which may trade on foreign exchanges that close many hours before the fund's pricing time. Intervening events might be company-specific (e.g. earnings report, merger announcement); country-specific (e.g. natural disaster, economic or political news, act of terrorism, interest rate change); or global. Intervening events include price movements in U.S. markets that are deemed to affect the value of foreign securities.