Vanguard Growth Index Fund tax distributions
The Vanguard Growth Index Fund is a very suitable candidate for placement in taxable accounts. The fund has been recommended for the following situations:
- An investor who is employed by a value company may wish to diversify away the risk to his human capital by allocating investment capital to growth companies.
- John Bogle has stated that Vanguard created style index funds with tax consequences as the paramount factor that should guide investors. [notes 1]
The table below summarizes the fund's relation to a number of tax factors.
|Favorable tax factors||Unfavorable tax factors|
Stock Migration: Moderate
The following tables provide long term data on the fund's history of both dividend and capital gains distributions. The first table also provides the historical distribution of qualified dividends.
The second table provides a database of the fund's accounting figures: the annual level of realized and distributed gains; its level of unrealized gains and loss carryforwards; as well as the annual in-kind redemption gains the fund has realized. These figures highlight the level of a fund's tax liabilities.
Because both manager turnover of securities inside the portfolio and investor turnover of fund shares can affect the level of gains realization, a third table provides historical turnover ratios.
The following table provides a view of the fund's historical distributions expressed in terms of yields. We can see that the fund distributed modest levels of capital gains during its first decade of existence, a period which coincided with a long bull market. The fund has not distributed a gain since 2001, a period marked by two bear markets, and which saw the introduction of an ETF share class in the fund. The fund has distributed 100% qualified dividends, which under the current tax regime, are taxed at lower capital gains tax rates.
The fund has changed tracking indexes twice in its history. The transition years of benchmark changes are marked in red shading.
|Year||Dividend Investor shares
|Dividend Admiral shares
|Dividend ETF shares
|Short-term Capital Gains
|Long-term Capital Gains
| Qualified Dividends
|(FY) Annual Return - Investor |
- The fund made a change in benchmarks from the MSCI US Prime Market Growth Index to the CRSP US Large Growth Index on 04/16/2013.
- The fund made a change of benchmark on 05/16/2003, moving from the S&P 500/Barra Growth Index to the MSCI US Prime Market Growth Index.
- The fund introduced ETF shares on 01/26/2004
The accounting figures and associated ratios (tables 3 and 4) can help one visualize some of the major determinants of a fund’s tendency to distribute taxable gains. These determining features include:
Turnover: The rate at which a fund manager sells securities within the fund has a major effect on potential gains realization. Single digit annual fund turnover percentages result in a low rate of realized gains. Similarly, fund shareholders' sales flows have major effects on a fund’s distribution tendencies. Net flows into the fund have the following effects:
- Constant inflows allow a fund manager to purchase a wide range of price lots for shares. The manager can select high basis shares when forced to sell a stock (this may realize a loss). The manager can also select low basis shares when redeeming a stock in-kind (a non-taxable transaction that can remove an unrealized gain out of the portfolio.)
- A large and growing net asset base serves to diffuse any realized capital gains across a large base of shareholders and reduces the per share gain distribution. Large outflows have the opposite effect; any gains realized are spread across a smaller asset base and result in higher per share distributed gains. 
The level of unrealized gains and carryover realized losses in a fund: A fund which defers gains realization accumulates unrealized appreciation, which when distributed, will be taxed; thus the unrealized gain/loss figure shows the potential gain (or loss) that would be realized if the portfolio was to be entirely liquidated. Any loss carryovers a fund possesses can be used to offset future realized gains (carryovers have an eight year expiration period). The third tab on the Table 3. spreadsheet shows the data in percentage of total assets form.
Net sales/redemptions: This statistic reveals whether investors are net buyers or sellers of the fund.
Realized gain/loss: A realized capital gain/loss is an increase (or decrease) in the value of a security that is "real" because the security has been sold by the portfolio manager. The capital gains/losses are "realized" by the fund, and any distributions to the shareholder as a result of realized gains (adjusted for any realized losses) are taxable during the tax year in which the security was sold. Realized losses can be used to offset realized gains in an attempt to reduce taxable gains. If realized losses are higher than realized gains, a fund can "carry forward" these excess losses to offset future gains. In-kind redemption gains are included as gains in this statistic. As these gains are not taxable, they must be deducted from the realized/gain tally to reflect the net gain/loss for the year. (see tax attributes for the net gain computation).
Distributed gains: A net realized gain will be distributed to shareholders as a capital gains distribution.
Unrealized gain/loss: An unrealized capital gain/loss (also called a "paper profit or loss") is an increase (or decrease) in the value of a security that isn't "real" because the security hasn't been sold. When a portfolio manager sells a security, however, the capital gains/losses become "realized" by the fund, and any realized gains (net of any losses) are taxable during the tax year in which the security was sold. Funds with low turnover rates, such as index funds, tend to have more unrealized gains than actively managed funds and are less likely to pass taxable gains on to investors. A fund's unrealized appreciation or depreciation figures are valuable because they can give an idea of whether a fund would need to distribute any gains if all of its securities were sold. Such information may help you determine your potential exposure to taxable distributions. This statistic is volatile, and will increase or decrease depending on market returns.
Loss carryforward: Realized losses can be “carried forward”, over a set span of years, to offset any future net realized gains.
In-kind redemptions: Instead of selling securities, a portfolio manager may elect to distribute securities in-kind to redeeming shareholders. Unlike a sale, an in-kind transfer is not taxable. This technique is frequently used in the ETF creation/redemption process. For institutional redemptions, a portfolio manager can select low-basis securities to transfer (removing the embedded tax liability) from the portfolio.
Reference article: Average net assets
Average net assets: Average net assets are derived from NSAR reports from the EDGAR database.
Redemptions: The dollar amount of fund shares sold by shareholders.
Sales: The dollar amount of fund shares bought by shareholders.
Turnover: The rate at which the fund manager sells securities within the portfolio. The reciprocal of this number reflects the average holding period of the portfolio. Low turnover often results in low capital gains realization.
R/ANA: The redemptions/average net assets (R/ANA) ratio reflects how fund shareholders are turning over their holdings in the fund. It is analogous to the investment manager's turnover ratio.
R/S: The redemption/sales ratio (R/S) illustrates whether investors are net buyers or sellers of the fund. A ratio of less than 1 means that investors are net purchasers of the fund. A ratio more than one means investors are net sellers of the fund. The R/ANA and R/S ratios, viewed together, can signal market timing activity within a fund. For example a fund showing an R/ANA ratio of 400% and an R/S ratio of 1 (equal buys and sells) is likely being market timed by fund shareholders.
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. The federal tax rates applicable to mutual fund distributions and investor sales of securities for the period 2013 onward are outlined below. Keep in mind that investment income may also be subject to state and local taxation.
- 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 39.6%. 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.
- 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, at 15% for taxpayers in the 25%, 28%, 33%, and 35% tax brackets, and at 20% in the 39,6% tax bracket. They are reported on tax Schedule D along with any other capital gains, and can be reduced by capital losses.
- Qualified dividends are the ordinary dividends [notes 3] that are subject to the same tax rate that applies to long-term capital gains. They should be shown in box 1b of the Form 1099-DIV you receive.
- 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.
- The Affordable Care Act imposes a Medicare surcharge of 3.8% on all net investment income (NII) once the taxpayer's adjusted gross income exceeds $200,000 (single) or $250,000 (married); while this tax is not part of the income tax, it has the same effect on investors as a higher tax rate. The NII tax begins to apply to individuals falling in the 33% tax bracket. Thus the top effective marginal tax rate is 23.8% on qualified dividends and long-term gains, 43.4% on ordinary investment income.
|Taxable income up to this level||Tax rate|
|Single||Married filing joint||Head of Household||Ordinary income||Long-term gains and qualified dividends|
In addition, there is a 3.8% Medicare tax rate on investment income in excess of an adjusted gross income of $200,000 ($250,000 for married filing jointly), and 0.9% on salary and self-employment income in excess of this level.
The annual fund accounting figures show that the Vanguard Growth Index fund, since its 2003 change to the MSCI benchmark, has provided turnover ratios inhabiting a range between 20% to 30% . This moderate turnover can be attributed to the fact that stock migration out of a large growth index can come in the following dimensions:
- An individual company becomes relatively smaller and migrates to a mid cap index;
- An individual company migrates to a value index;
- An individual company is bought out or merged with a second company.
Shareholder turnover, revealed in the Redemptions/Average Net Assets (R/ANA) metric, shows that shareholders have tended to chase performance in the fund. The fund received very strong inflows during the 1990's, a period marked by growth stock outperforming value stocks; the fund saw net redemption during the 2000-2001 bear and 2008 bear markets, and experienced much lower levels of inflows during the 2001-2008 period marked by value stocks outperforming growth stocks. [notes 4]
A look at realized net gains/losses shows that the fund realized net losses in the 2000-2001 and 2008-2009 bear markets (see the second tab, tax attributes in Table 3 above). These losses produced loss carryforwards. These carryforward losses have been used to offset realized gains during ensuing periods of market recovery. One should remain cognizant of the fund's tendency to distribute moderate levels of taxable gains absent carryforward losses.
The following table presents the federal tax cost on the fund's historical distributions (see second tab, table 6.) under two scenarios: the tax rate regime from (2010-2012) and the current tax regime (with dividends and long term capital gains taxed at 0%, 15% or 20% depending on tax rates, and an additional 3.8% ACA Net Investment Income tax imposed at higher tax rates). Keep in mind that distributions can also be subject to state and local taxation, with marginal rates ranging from 0% to 12% (an average 5% state tax rate will add an approximate 0.05% to the annual tax cost of holding the fund.) The average is based on the results from 2004-2010, the period comprising the qualified dividend tax regime. The 2004- 2010 average dividend yield (1.00%) is very close to the life of fund average yield (1.11%). The fund distributed capital gains during the 1992-2000 period, averaging 0.28% per annum short term gains, and 0.66% per annum long term gains.
The table does not include the capital gains tax cost associated with selling the fund at a gain. [notes 5]
John Bogle's original insight into the relative tax efficiency of growth indices is evidenced in the following table of relative yields:
Almost all of the dividends distributed by Equity REITS come in the form of non-qualified dividends. Non-qualified dividends are taxed at marginal income tax rates.