Vanguard international funds FAQ

= Introduction =

With the introduction of VFWIX All-World ex-US fund, many people seem to wonder whether they should choose VGTSX Total International or VFWIX. Here is an attempt to address frequently asked questions in a single topic so that people can point to this topic later. = Basic Questions =

What broad international index funds does Vanguard have?

 * VGTSX Vanguard Total International Stock Index Fund
 * VFWIX Vanguard FTSE All World ex US Index Fund

Should I buy VGTSX or VFWIX?
Buy VGTSX in a tax-advantaged account and VFWIX in a taxable account.

VFWIX


 * 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 (0.40%) is higher than that of VGTSX (0.27%), but that's more or less offset by Foreign Tax Credit, which is expected to be around 0.16%.
 * 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 VGTSX 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 prospectus for VTSMX Total Stock Market.)

VGTSX


 * Not as tax efficient as VFWIX. 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 (0.27%) is lower than that of VFWIX (0.40%).
 * 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 VTSMX Total Stock Market or VFWIX in a taxable account?
In general, you want to put VFWIX 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 VFWIX 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 VGTSX. 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 VGTSX in a taxable account. What should I do?
If you have loss in your VGTSX or a small amount of capital gains, you can sell it and buy VFWIX. Otherwise, you could direct new money, including distributions from VGTSX, into VFWIX. For simplicity, you should just stick with VGTSX because the difference is probably not significant enough to make up for the difference in capital gains from selling.

Wow, VFWIX has expense ratio of 0.40%? Should I buy VEU, the ETF version of VFWIX, 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 VTMGX 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 VFWIX. This combination is slightly cheaper and more tax efficient than VFWIX. 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 VFWIX is 72.69% as of 06/2008 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. You can of course consider VFWIX.

= Advanced Questions =

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

Both VGTSX and VFWIX appear to lack small-cap. What should I buy to fill that area?
Unfortunately, this is an area that Vanguard isn't good at. See International Small-Cap 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.

= See also =