Vanguard Mid Cap Value Index Fund tax distributions

From Bogleheads

The Vanguard Mid-Cap Value Index Fund is a suitable candidate for placement in taxable accounts. The fund is sometimes recommended, due to its higher exposure to measures of value, as a substitute for a large cap index in portfolios that employ a value tilt, such as the Schultheis "Coffeehouse" portfolio illustrated in Figure 1.

In addition, 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.

Table 1. Summary
Fund Distributions.jpg Favorable tax factors Fund Distributions.jpg Unfavorable tax factors Fig. 1 Bill Schultheis's "Coffeehouse" portfolio

Historical gains distributions : Recently none
Qualified dividends: Yes (avg. 87%)
Section199a deduction: Yes (minimal)
Turnover: Moderate
ETF shares : Yes

Dividends: Higher than growth indexes
Stock Migration: High

CoffeeHouse Portfolio.PNG

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.

Distributions

The following table provides a view of the fund's historical distributions expressed in terms of yields. We can see that the fund has not distributed any capital gains during the short years of its existence. The fund has distributed approximately 78% qualified dividends, which under the current tax regime, are taxed at lower capital gains tax rates. The higher taxable dividend yields distributed by value index funds make them less tax efficient than lower yielding blend and growth index funds.

The fund has changed tracking indexes once in its history. The transition year of the benchmark change is marked in red shading.

Table 2. Vanguard Mid Cap Value Index Fund Taxable Distributions
Year Dividend Investor shares
[1]
Dividend Admiral shares
[1]
Dividend ETF shares
[1]
Short-term Capital Gains
[2]
Long-term Capital Gains
[2]
Qualified Dividends
[3]
(FY) Annual Return - Investor
[4]
2019 1.90%% 2.28% 2.26% 0.00% 0.00% 90.86% 27.82%
2018 2.29% 2.41% 2.41% 0.00% 0.00% 95.53% -12.53%
2017 1.92% 2.04% 2.04% 0.00% 0.00% 92.96% 16.91%
2016 2.02% 2.14% 2.14% 0.00% 0.00% 92.24% 15.11%
2015 2.01% 2.13% 2.13% 0.00% 0.00% 92.24% -1.91%
2014 1.86% 2.00% 2.00% 0.00% 0.00% 89.84% 13.84%
2013 1.80% 1.95% 1.95% 0.00% 0.00% 93.19% 37.42%
2012 2.21% 2.35% 2.35% 0.00% 0.00% 84.09% 15.91%
2011 1.97% 2.11% 2.11% 0.00% 0.00% 90.52% -0.44%
2010 1.99% - 2.13% 0.00% 0.00% 90.52% 21.63%
2009 2.14% - 2.30% 0.00% 0.00% 88.90% 37.61%
2008 2.73% - 2.86% 0.00% 0.00% 75.86% -36.64%
2007 2.48% - 2.59% 0.00% 0.00% 77.21% -4.37%
2006 2.50% - 2.63% 0.00% 0.00% 69.85% 12.40%

  • FY 2013 - The fund changed benchmarks from the MSCI US Mid Cap Value Index to the CRSP US Mid Cap Value Index on 04/16/2013.
  • FY 2011 - admiral shares introduced, dividend annualized

Accounting data

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:

  1. 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.)
  2. 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. [5]

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. The third tab on the Table 3. spreadsheet shows the data in percentage of total assets form. Tab four provides annual per share distribution data.

Table 3.


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Definition of terms
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 is not "real" because the security has not 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 an unlimited 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.

Turnover

Reference article: Average net assets

Table 4.


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Definition of terms
Average net assets
Average net assets are derived from NSAR and N-CEN 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.

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. 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.

  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 37%. 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 12% tax brackets, at 15% for taxpayers in the middle tax brackets, and at 20% in between the 35% the 37% tax brackets. 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 [notes 2] 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.
  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.
  5. 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, 40.8% on ordinary investment income.


Filing status and annual taxable income - 2024 Ordinary income tax rate
Single Married Filing Jointly or Qualified Widow(er) Married Filing Separately Head of Household Trusts and Estates
$0-$11,600 $0-$23,200 $0-$11,600 $0-$16,550 $0-3,100 10%
$11,601-$47,150 $23,201-$94,300 $11,601-$47,150 $16,551-$63,100 n/a 12%
$47,151-$100,525 $94,301-$201,050 $47,151-$100,525 $63,101-$100,500 n/a 22%
$100,526-$191,950 $201,051-$383,900 $100,526-$191,950 $100,501-$191,950 $3,101-$11,150 24%
$191,951-$243,725 $383,901-$487,450 $191,951-$243,725 $191,951-$243,700 n/a 32%
$243,726-$609,350 $487,450-$731,200 $243,726-$365,600 $243,701-$603,950 $11,151-$15,200 35%
$609,351+ $731,201+ $365,600+ $603,951+ $15,201+ 37%
  • Capital gains on collectibles and small business stock are taxed at the normal tax rate but a maximum of 28%. Collectibles are defined in 26 USC 408(m). Small business stocks are per Section 1202. Reference: Alistair M. Nevius (May 1, 2013). "Qualified small business stock". Association of International Certified Professional Accountants. Journal of Accountancy. Retrieved December 30, 2017.
  • Unrecaptured Section 1250 gain (from depreciation taken on real property) is taxed at the normal tax rate but a maximum of 25%.
  • 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. See: ACA net investment income tax
Filing status and annual taxable income - 2024 Long-term capital gain rate
Single Married Filing Jointly or Qualified Widow(er) Married Filing Separately Head of Household Trusts and Estates Qualified dividends and other investments
$0-$47,025 $0-$94,050 $0-$47,025 $0-$63,000 $0-$3,100 0%
$47,026-$518,900 $94,041-$583,750 $47,026-$291,850 $63,001-$551,350 $3,101-$15,450 15%
$518,901+ $583,751+ $291,851+ $551,351+ $15,451+ 20%
Filing status and annual taxable income - 2023 Ordinary income tax rate
Single Married Filing Jointly or Qualified Widow(er) Married Filing Separately Head of Household Trusts and Estates
$0-$11,000 $0-$22,000 $0-$11,000 $0-$15,700 $0-$2,900 10%
$11,001-$44,725 $22,001-$89,450 $11,001-$44,725 $15,701-$59,850 n/a 12%
$44,726-$95,375 $89,451-$190,750 $44,726-$95,375 $59,851-$95,350 n/a 22%
$95,376-$182,100 $190,751-$364,200 $95,376-$182,100 $95,351-$182,100 $2,901-$10,550 24%
$182,101-$231,250 $364,201-$462,500 $182,101-$231,250 $182,101-$231,250 n/a 32%
$231,251-$578,125 $462,501-$693,750 $231,251-$346,875 $231,251-$578,100 $10,551-$14,450 35%
$578,126+ $693,751+ $346,876+ $578,001+ $14,451+ 37%
  • Capital gains on collectibles and small business stock are taxed at the normal tax rate but a maximum of 28%. Collectibles are defined in 26 USC 408(m). Small business stocks are per Section 1202. Reference: Alistair M. Nevius (May 1, 2013). "Qualified small business stock". Association of International Certified Professional Accountants. Journal of Accountancy. Retrieved December 30, 2017.
  • Unrecaptured Section 1250 gain (from depreciation taken on real property) is taxed at the normal tax rate but a maximum of 25%.
  • 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. See: ACA net investment income tax
Filing status and annual taxable income - 2023 Long-term capital gain rate
Single Married Filing Jointly or Qualified Widow(er) Married Filing Separately Head of Household Trusts and Estates Qualified dividends and other investments
$0-$44,625 $0-$89,250 $0-$44,625 $0-$59,750 $0-$3,000 0%
$44,626-$492,300 $89,251-$553,850 $44,626-$276,900 $59,751-$492,300 $3,001-$14,650 15%
$492,301+ $553,851+ $276,901+ $492,301+ $14,651+ 20%


Tax analysis

The annual fund accounting figures show that the Vanguard Mid-Cap Value Index fund, since its 2006 inception, has provided turnover ratios inhabiting a range between 14% to 47%. This turnover can be attributed to the fact that stock migration out of a mid-cap value index can come in the following dimensions:

  1. An individual company becomes relatively smaller and migrates to a small cap index;
  2. An individual company becomes relatively larger and migrates to a large cap index;
  3. An individual company migrates to a growth index;
  4. 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, on average, tended to maintain holding periods in the fund for 2 to 4 years.

A look at realized net gains/losses shows that the fund realized net losses in all but two fiscal years (see the second tab, tax attributes in Table 3 above). These losses produced loss carryforwards. These carryforward losses were used to offset realized gains in 2011 and 2013. A considerable portion of fund assets is held in the ETF share class. [notes 3]

The following table presents the federal tax cost on the fund's historical distributions the current tax regime (with dividends and long term capital gains taxed at a tax rates of 0%, 15%, or 20% depending on marginal tax rate, along with an additional 3.8% ACA Net Investment Income tax accessed 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 0.12% to the annual tax cost of holding the fund.)

The table does not include the capital gains cost associated with selling the fund at a gain. [notes 4]

Table 6.


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John Bogle's original insight into the relative tax inefficiency of value index funds vs. growth index funds is evidenced in the following table of relative yields:

Table 7.


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Notes

  1. I expect that the new style indexes will greatly assist investors in meeting their particular investment objectives. In the accumulation phase of your life, you might be well served by a relatively low dividend yield to minimize your taxes. At retirement and in the distribution phase of your life, you would presumably be better served by a higher yield.

    — John Bogle, Bogle On Mutual Funds: New Perspectives for the Intelligent Investor, ISBN 978-1556238604, p. 184.
  2. Fairmark says:

    A portion of your ordinary dividend may be nonqualified because it can include items like these:

    • Taxable interest. When a mutual fund receives taxable interest, the income gets paid out as a dividend. It's a dividend when it goes out of the mutual fund, but it wasn't a dividend when it came into the mutual fund, so it can't be a qualified dividend.
    • Nonqualified dividends. Your mutual fund may receive dividends that are nonqualified. For example, the mutual fund may sell shares just 35 days after buying them, but after receiving a dividend. The mutual fund has to hold the shares at least 61 days to have a qualified dividend. Any amount the mutual fund receives as a nonqualified dividend gets paid to you as a nonqualified dividend.
    • Short-term capital gain. When a mutual fund has a short-term capital gain, it pays this amount to the mutual fund shareholders as an ordinary dividend.
    • Holding mutual fund shares less than 61 days. You should also be aware that any dividend you receive on mutual fund shares held less than 61 days is a nonqualified dividend, even if the mutual fund reports that amount to you as a qualified dividend. You don't have to buy the shares 61 days before the dividend is paid, but the total amount of time you hold the shares (including time before and after the dividend) has to be at least 61 days.
  3. 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.

  4. Vanguard does not quantify conversions (investor/admiral and mutual fund/ETF). These non-transaction conversions inflate the reported shareholder ratios. At inception, the fund issued both mutual fund and exchange-traded fund shares. The fund has maintained a significant ratio of ETF assets to total fund assets.
  5. This table indicates the additional cost for the capital-gains tax when you sell, assuming that you pay taxes on the distribution and reinvest the after-tax portion of the distribution; since it is a one-time cost, the effect is annualized. For example, if you hold an investment for 30 years and lose 10% to taxes when you sell, that is equivalent to losing 0.35% every year. Thus, if you sell the fund, your cost will be the sum of the Table 6 and Table 8 costs. However, you would not pay the Table 8 cost on any stock which you either leave to your heirs or donate to charity, and thus may not pay that cost on your full investment. In particular, you might estimate your total tax cost by using the low-return line in Table 8; if stock returns are high, you will have a large taxable account and will reduce the tax cost by taking longer to deplete it or by not spending it all during your lifetime. Taxes are computed at a tax rate of 15% on long-term gains (except in the "rate rises to 20% column", which applies if that tax reduction is allowed to expire), and on qualified dividends (except in the "no QDI" column, which applies if the tax reduction on qualified dividends expires and the rate is 35%). Although not tabulated, keep in mind that investors in the lower tax brackets (15% or lower) pay lower federal tax rates on investment income for the period 2003 - 2019, and reap higher after-tax returns, outside of tax-exempt municipal bonds, in all asset classes.
    Table 8. Additional hypothetical tax costs (after taxable funds are sold)
    Fund Pre-tax Returns Distributions Tax Cost Annualized cost over 10 years Annualized cost over 20 years Annualized cost over 30 years 30-year cost if CG tax rate rises to 20%
    Any bond any all any 0.00% 0.00% 0.00% 0.00%
    Tax-efficient stock, low returns 5.00% 2.00% 0.30% 0.36% 0.30% 0.25% 0.33%
    Tax-efficient stock, medium returns 8.00% 2.00% 0.30% 0.63% 0.47% 0.37% 0.50%
    Tax-efficient stock, high returns 11.00% 2.00% 0.30% 0.84% 0.58% 0.43% 0.58%
    Tax-inefficient stock, low returns 5.00% 4.00% 1.00% 0.12% 0.10% 0.09% 0.12%
    Tax-inefficient stock, medium returns 8.00% 4.00% 1.00% 0.43% 0.33% 0.26% 0.35%
    Tax-inefficient stock, high returns 11.00% 4.00% 1.00% 0.66% 0.47% 0.35% 0.47%

See also

References

  1. 1.0 1.1 1.2 Dividend data is derived from the Complete filings: N-CSR reports back to 2003; N-30D reports back to 1994
  2. 2.0 2.1 Capital Gains are derived from annual reports, and are calculated by dividing the dollar amount capital gain distribution by the average net assets of the fund, derived from N-CEN and NSAR reports
  3. Data derived from Vanguard site.
  4. data derived from annual reports.
  5. Larry E. Swedroe, What Wall Street Doesn’t Want You To Know, 2001, pp.227-28. ISBN 0312335725

External links

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