Vanguard - preliminary cap gains estimates are out

[MichaelB]

Thanks, Michael B, for that info. Didn't know any of it even tho I occasionally wonder about funds vs ETF and read articles about them. Do you by chance have a link to a VG (or other) article about that? Do you have a brief explanation of how ETF funds can exchange shares w/o recognizing CGs?

Before you mentioned that, I thought that it was because those 3 funds that pb4uski mentioned are passive index funds and I thought one of their attributes is that they have minimal CG distributions.

Here are a couple of links you may find helpful. A google of "ETF redemption units" or "ETF creation units" will bring up many more links.

http://www.ici.org/viewpoints/view_12_etfbasics_cremation

An Inside Look At ETF Construction

Basically, during the day, the market price of the ETF diverges slightly from the price of the basket of securities it represents. Securities law allows an authorized investor to buy (or sell) the ETF but actually take delivery (or provide) the underlying stocks, so when, during a market sell off the price of the ETF falls, say, 0.5% below the asset value (NAV), an institutional investor buys the ETF but actually takes delivery of the basket of individual stocks. They turn around and immediately sell the stocks, and pocket that 0.5% difference, minus transaction cost. This is how the market keeps the price of the ETF close to the net asset value of the stocks. This transaction is carried out directly with the ETF creator, in this case, Vanguard.

The critical aspect is that, when Vanguard carries out this transaction, the IRS allows them to give the institutional investor any specific share of stock in their inventory but not record it as a capital gain or loss. Vanguard, of course, will therefore transfer the shares with the lowest cost basis, which are also the highest unrealized profit. That way, Vanguard is constantly exchanging equities for cash or ETF units, and always transferring out the stocks with profit.

Contrast this to a regular mutual fund, when it sells individual stocks it must record the transaction as a gain or loss, and the mutual fund holder now has a taxable gain, even if they didn't sell.

Vanguard us the only company that has some mutual funds that are also ETFs. This is a real advantage for the fund holder.

A poor explanation for sure. For this to work well, the ETF needs a good amount of volume, this is why it's important to avoid ETFs that don't trade a lot.

 

[kaneohe]

MichaelB, thanks for that "short" explanation. Appreciate the time and thought that went into it. Still digesting it............so who is that authorized investor and are they obligated to accept both the gains and losses?

 

[MichaelB]

MichaelB, thanks for that "short" explanation. Appreciate the time and thought that went into it. Still digesting it............so who is that authorized investor and are they obligated to accept both the gains and losses?

I know. Sorry about that.

Here's another article that explains this process. The ETF Creation/Redemption Process Made Simple | Seeking Alpha

When shares are transferred between the ETF creator (Vanguard) and the authorized participants in creation or redemption units, the gain or loss disappears. There is no gain. That's the beauty of an ETF.

Edit to add: the investor (us) still has capital gain or loss when selling shares. The difference is with the ETF you only have the gain when you sell, while with the mutual fund you record part of that gain when the fund sells.

 

[CountryBoy]

I have a question, maybe one you can answer? A few of here in the office have ONE fund in our 401K (managed by Aon Hewitt), the Vanguard Wellington Fund. For myself, it's around 230K. I was just wondering why it shows on my account as VWELX (Investor Share)? I have a taxable portfolio of 4 other funds, all Admiral.

I thought Vanguard Wellington switched to Admiral once you reached a 50K balance? Does the same thing not apply to 401Ks?

 

[Amethyst]

Other than not liking to pay taxes, is there any other reason to dislike receiving capital gains income?

Amethyst

 

[Amethyst]

I asked my VG rep a similar question a while ago. The response was that your accounts get converted to Admiral when VG decides to convert them. My husband's tiny 401K did get converted, at a much lower balance than yours, so my advice would be to call VG and ask them directly.

Amethyst

I have a question, maybe one you can answer? A few of here in the office have ONE fund in our 401K (managed by Aon Hewitt), the Vanguard Wellington Fund. For myself, it's around 230K. I was just wondering why it shows on my account as VWELX (Investor Share)? I have a taxable portfolio of 4 other funds, all Admiral.

I thought Vanguard Wellington switched to Admiral once you reached a 50K balance? Does the same thing not apply to 401Ks?

 

[FUEGO]

Darn, no "gains" for me either!

 

[kramer]

Other than not liking to pay taxes, is there any other reason to dislike receiving capital gains income?

Amethyst

Funds that consistently produce capital gains tend to have higher turnover. Turnover has some costs and the costs vary by asset class and country. These costs are not part of the expense ratio.

Generally, the costs are the transaction fees themselves and market impact costs. These costs can be very high in emerging markets, less so for, say, big liquid stocks in the USA.

 

[MichaelB]

Other than not liking to pay taxes, is there any other reason to dislike receiving capital gains income?

Amethyst

Aside from Kramer's observation, this is all about taxes, having a tax liability even though you didn't sell. The fund distribution may have some short term taxable gain, which can be taxed at a higher rate, but overall, it is about paying now vs paying later.

 

[nun]

The only capital gains for me are inside retirement accounts.

 

[Amethyst]

Thanks. I deal with that by taking the gains in cash, versus reinvesting them. I just wondered if there were some other catch (in addition to what Kramer said, which I hadn't realized and which makes sense), such as the gains reducing the value of your investment.

Amethyst

Aside from Kramer's observation, this is all about taxes, having a tax liability even though you didn't sell. The fund distribution may have some short term taxable gain, which can be taxed at a higher rate, but overall, it is about paying now vs paying later.

 

[grasshopper]

I have been known to sell before the EOY, just so I will know to the penny my LTCG. Sometimes it is important for taxes to know what a gain is rather than wait for income, short-term and long-term gains, to be distributed.

 

[Looking4Ward]

The CG distribution for my Wellington alone is going to be in the mid-5 figure range.

Learning a lesson about tax consequences of equity MF's in a taxable account from all of this, I can see the advantages of instead having those funds in VTI (65%) and BND (35%).

But if I exchange (sell) Wellington for those two funds, I'll incur a six-figure capital gain.

Am I stuck in Wellington? Is there a way to exchange to those two ETF's without the tax consequences on the capital gain?

 

[MichaelB]

The CG distribution for my Wellington alone is going to be in the mid-5 figure range.

Learning a lesson about tax consequences of equity MF's in a taxable account from all of this, I can see the advantages of instead having those funds in VTI (65%) and BND (35%).

But if I exchange (sell) Wellington for those two funds, I'll incur a six-figure capital gain.

Am I stuck in Wellington? Is there a way to exchange to those two ETF's without the tax consequences on the capital gain?

It's possible that with a 65/35 allocation to the two ETFs your capital gain might have been larger. If you keep the allocation at that same percentage split, as Vanguard Wellington does, your equity portion would have risen much higher, you would have to shift $$ from equity to FI, and in doing so, incurred a large gain.

 

[Looking4Ward]

It's possible that with a 65/35 allocation to the two ETFs your capital gain might have been larger. If you keep the allocation at that same percentage split, as Vanguard Wellington does, your equity portion would have risen much higher, you would have to shift $$ from equity to FI, and in doing so, incurred a large gain.

Ahh, yes - I would need to rebalance to keep the AA in check and that would cause CG events. Got it.

 

[braumeister]

FWIW, I just happened to find this similar set of rough estimates for Fidelity funds:
http://www.fmandi.com/distributions/2014_distributions.pdf

 

[Amethyst]

Here is one for T. Rowe Price; although I had to log in to my account to see it, so I don't know if the link will work for others:

2014 Preliminary Year End Distributions - T. Rowe Price