Vanguard Asset Allocation Fund tax distributions

The Vanguard Asset Allocation Fund is a questionable candidate for placement in taxable accounts. The fund uses a tactical asset allocation strategy to allocate its investments across three discrete asset classes:
 * 1) US stocks, as represented by the S&P 500 Index.
 * 2) US bonds, as represented by long term treasury bonds.
 * 3) US cash, as represented by money market instruments.

Since 2000, Vanguard has reported the shifts in the fund's tactical asset allocation.

The fund is one of the underlying funds in Vanguard's series of LifeStrategy funds. The inclusion of a tactical asset allocation component to these funds is a controversial topic among forum participants, who often criticize this investment policy.

Distributions
The following table provides long term data on the Vanguard Asset Allocation Fund's history of dividend and capital gains distributions. (Complete data extends back to 1994. The fund began operations in 1991 and distributed capital gains during its first three years of operations). Qualified dividend data (with the exception of unavailable figures for fiscal year 2005) are provided, as are data on the percentage of treasury and government security dividends (which are exempt from state and local income tax in most states). Vanguard provides government obligations data back to 2004.

The tax efficiency of the fund is very dependent on the existence of long term carryforward losses. The fund's carryforward losses from the two bear markets in the first decade of the twenty-first century have resulted in no taxable capital gains distributions since 2001. One should note that, without the benefit of loss carryforwards, the fund distributed considerable amounts of both short term and long term gains during the 1991 - 2000 bull market (see the second tab of Table 4 below for loss carryforward data).

Note:
 * Current attributes and distributions: Vanguard

Tactical asset allocation changes
The following table provides the fund's tactical asset changes since 2000. The fund has been managed from inception by Mellon Capital Management Corporation.

Tax rates
Mutual fund distributions will be taxed according to the tax laws governing the investment over the holding period of the investment, which are subject to change. The actual tax imposed will depend upon each individual's tax rate and the timing of purchases and sales. Bond fund interest income subject to federal taxation is taxed at marginal tax rates. The federal tax rates applicable to mutual fund distributions and investor sales of securities for the period 2008 - 2012 are outlined below. Keep in mind that investment income may also be subject to state and local taxation. Treasury bond interest is usually not taxed at the state and local levels.
 * 1) Short-term capital gains distributions are made from realized gains on securities held for one year or less. Short-term gains are taxed at ordinary income tax rates up to 35%. Mutual fund short-term gain distributions are included in a fund's ordinary dividend distribution; therefore, capital losses may not be subtracted from these distributions when computing taxes.
 * 2) Long-term capital gains distributions are made from realized gains on securities held for more than one year. Long-term gains are taxed at 0% for taxpayers in the 10% and 15% tax brackets and at 15% for taxpayers in the 25%, 28%, 33%, and 35% tax brackets. (These tax rates are mandated for 2008-2012.) They are reported on tax Schedule D along with any other capital gains, and can be reduced by capital losses.
 * 3) Qualified dividends are the ordinary dividends that are subject to the same 0% or 15% maximum tax rate that applies to net capital gain. They should be shown in box 1b of the Form 1099-DIV you receive. Qualified dividends are subject to the 15% rate if the regular tax rate that would apply is 25% or higher. If the regular tax rate that would apply is lower than 25%, qualified dividends are subject to the 0% rate.
 * 4) When you sell at a loss you will either offset capital gains which would have otherwise been taxed at your capital gains rate or you will offset income (up to $3,000 maximum per year) which would have otherwise been taxed at your marginal income tax rate, or both. If you offset capital gains that would have otherwise not been taxed at all (because your capital gains tax rate is 0%) then this part of the tax loss harvest may be an outright loss.

Tax analysis
The following tables examine the tax consequences of holding the Vanguard Asset Allocation Fund in a taxable account. Due to the major impact of loss carryforwards on fund tax obligations, the spreadsheet table includes three tabs which show returns and tax regimes. The tables include a 5% state tax rate (which of course may vary according to state).

The tables include:
 * 1) An average tax cost table, which uses the life of fund average dividend and capital gains distributions and applies the current tax regime percentages of qualified dividend and government bond interest exclusion figures to the averages. The current tax regime, as well as a regime which eliminates qualified dividends and raises marginal tax rates and capital gains rates is examined.
 * 2) An average cost table for the period 2004-onwards (tab 2), which incorporates the qualified dividend tax regime, as well as a period when the fund utilized loss carryforwards to avoid taxable gains realization. As the fund retains carryforwards extending through 2017, this table provides a more accurate illustration of the fund's expected tax efficiency through 2017. The current tax regime, as well as a regime which eliminates qualified dividends and raises marginal tax rates and capital gains rates is examined.
 * 3) An average cost table for the period 1994-2003 (tab 3), which examines a period when the fund's dividend and interest earnings were higher and when the fund consistently realized taxable gains. The fund did not accrue loss carryforwards until 2002. The current tax regime, as well as a regime which eliminates qualified dividends and raises marginal tax rates and capital gains rates is examined.

Table 4.