Best Vanguard Funds for High Tax Bracket Investor

[Jeff55]

I am moving $1M into Vanguard. It is non-IRA, so I am looking for advice from you pro's out there as to what funds(s) would be best to minimize taxes. I am 57 years old so I would probably be comfortable with a 65% stock-35% bonds ratio. Advice on the best bond fund to be in anyone? I am in the 39% tax bracket.
Thanks,
Jeff

 

[firewhen]

Jeff55,

Vanguard will give you a free financial plan moving that much to them. You could go into a money market fund until you speak to them and decide.

For the bonds, in your bracket you might want a tax-free fund. I cannot tell what state you are in, but they have many state tax-free funds, especially for the bigger, higher-tax states.

For the stocks, the total stock market index, gives you the broadest base domestic offerings, and you would qualify for admiral, with lower expenses.

If you want international exposure, they have index funds for that too but many argue that indexing does not work as well for international funds.

 

[Surfdaddy]

1. Set up an asset allocation if you haven't already done this
2. Put any REITs in tax advantaged accounts first if you have any deductable IRAs, 401Ks, etc.
3. Put any taxable bonds in tax advantaged accounts. For non tax advantaged accounts use a tax free bond fund (we use VWIUX). You may also have state tax-free funds available.
4. Buy index funds for stocks, they are low cost and low turnover, therefore best for taxes
5. Some stock segments have tax managed funds, use these where possible (example, I own Tax-Managed Small)
6. Rebalance annually
7. Watch it grow!

 

[LOL!]

Are there any REAL advantages to the Vangard tax-managed funds versus their same fund without same-managed in the title? It seems to me that the tax-managed funds have a redemption fee that makes them less desirable for rebalancing.

 

[ats5g]

Are there any REAL advantages to the Vangard tax-managed funds versus their same fund without same-managed in the title? It seems to me that the tax-managed funds have a redemption fee that makes them less desirable for rebalancing.

LOL,

I think that there are a couple of possible advantages of the tax managed funds over the regular index funds:

1) A perusing of the SEC filings for the tax managed funds shows that they have never distributed a capital gain. For example, VTGIX, VMCAX, and VTMFX distributed no capital gains since 1994 [inception], while VFINX and VTSMX distributed capital gains from 1994 until around 2000-2001, but havent' since.

2) In the small cap arena, in addition to not distributing any capital gains since inception [1999], all the dividends distributed by VTMSX are qualified dividends. Contrast this with NAESX and VIVSX whose dividends are only b/w 60-70% qualifying. See Barry Barnitz's Financial page for the docs.

3) The TM Int'l fund VTMGX also distributes dividends that are 100% qualifying, plus the investors can claim the foreign credit. This was a problem if people used the Total Int'l fund or Developed Markets fund in a taxable account, which didn't allow investors can claim the foreign credit. But not really a problem if investors used the Euro, Pacific, and EM index funds.

- Alec

 

[LOL!]

ats5g, thanks for the well-worded response.

 

[calmloki]

LOL,

I think that there are a couple of possible advantages of the tax managed funds over the regular index funds:

1) A perusing of the SEC filings for the tax managed funds shows that they have never distributed a capital gain. For example, VTGIX, VMCAX, and VTMFX distributed no capital gains since 1994 [inception], while VFINX and VTSMX distributed capital gains from 1994 until around 2000-2001, but havent' since.

2) In the small cap arena, in addition to not distributing any capital gains since inception [1999], all the dividends distributed by VTMSX are qualified dividends. Contrast this with NAESX and VIVSX whose dividends are only b/w 60-70% qualifying. See Barry Barnitz's Financial page for the docs.
.....

- Alec

Which all looks great, but again I am troubled by the fact that over 37% of the NAV of VTMSX, for instance, is unrealized capitol gains. If a new investor ends up paying the piper for those gains if/when the fund is dissolved that's going to sting. At what point do those gains become realized? What is the amount of risk that a new investor in VTMSX is taking on? Please note, I am an investing beginner, this may be no threat at all and of no concern - but can anyone explain why it's not a risk to be factored in and how that risk is assessed?

 

[FinanceDude]

Try to make sure the bomd fund you choose is specific to your state if possible.

Also, VERY IMPORTANT, check out what the percentage of AMT bonds held in the portfolio is, and keep that as low as possible.........

 

[JohnP]

Jeff55

As I see it, it mainly depends on whether you want to get income or not from this non-tax advantaged pot of money at this particular time of your life...

I support having tax-managed funds appropriately suggested by Ats5g, especially if you will not be drawing money from this account for a few years.

On the other hand, (since you mentioned the 39% tax bracket) if this non-tax advantaged pot of money will be tapped for retirement income, you may want to consider the fed and state tax-free funds as a part of your bonds component. We have about 15% of our stash in the state and fed tax-free MM account since we are finally ready to join the SWR crowd. VOHXX pays 3.4% which is equivalent to 6% yield for the 39% bracket - other states are available. I figure if you are in the 39% bracket, then you have a big state bite also so these funds are useful in the WD stage.

JohnP

 

[ats5g]

Which all looks great, but again I am troubled by the fact that over 37% of the NAV of VTMSX, for instance, is unrealized capitol gains. If a new investor ends up paying the piper for those gains if/when the fund is dissolved that's going to sting. At what point do those gains become realized? What is the amount of risk that a new investor in VTMSX is taking on? Please note, I am an investing beginner, this may be no threat at all and of no concern - but can anyone explain why it's not a risk to be factored in and how that risk is assessed?

I can see your concern. I spot checked a few other low turnover small cap funds [NAESX, FLPSX, OTCFX, VEXMX]. Looks like they’ve got a significant amount of unrealized capital gains as well [anywhere from 25-40%]. So, I think VTMSX’s unrealized gains are in line with other low turnover small cap funds.

As for VTMSX being dissolved, with $2 billion in assets, I have a hard time believing Vanguard would do that.

The gains become realized whenever the fund sells a share of stock with gains. However, these gains can be offset by selling a share of stock with losses. The following is from page 1 of VTMSX’s prospectus:

An Introduction to Tax-Managed Investing
Most mutual funds seek to maximize pre-tax total returns, without regard to the personal
tax consequences for investors. Yet most investors stand to lose a significant portion of
their investment returns to federal, state, and local taxes. Fund dividends and short-term
capital gains are now taxed at federal income tax rates as high as 35%; and for long-term
capital gains, the rates can be up to 15%. The Vanguard Tax-Managed Funds aim to minimize
the impact of taxes on investors’ total returns by operating in a tax-efficient manner.
Each Fund uses these tax-management techniques:

■Low turnover. Each Fund minimizes turnover by employing an index-oriented approach
to stock investing. Instead of trading frequently, the Fund simply buys and holds all, or a
representative sample, of the stocks that make up its benchmark index. Frequent trading—
a hallmark of many actively managed funds—causes the Fund to realize capital
gains, which must then be distributed to shareholders, reducing after-tax returns.

■A disciplined sell-selection method. When selling specific securities, each Fund will select
a specific share lot—more often than not, the highest-cost shares—in order to minimize
realized capital gains. In addition, the Fund may sell securities at a loss in order to offset
realized capital gains that would otherwise have to be distributed to shareholders.

■Bias against taxable dividend income. The Tax-Managed Balanced and Tax-Managed Capital
Appreciation Funds minimize taxable dividend income by focusing on the lower-yielding
stocks in their shared benchmark index (the Russell 1000 Index). In addition, the bond
portion of the Tax-Managed Balanced Fund is made up of municipal securities, which
generate tax-exempt dividends.

Note that all of Vanguard’s Tax Managed funds certainly can distribute capital gains, but they try very hard not to do so.

Also, on the AMT bond issue. Morningstar recently reported the following:

Vanguard Cuts AMT Exposure in Municipal-Bond Funds
Vanguard recently completed the sale of all bonds carrying Alternative Minimum Tax exposure in its 13-fund investment-grade muni bond lineup. Because Vanguard didn't finish the changes until early 2007, income earned in January and February may still be subject to AMT for 2007 tax purposes, for investors who pay this tax. Vanguard will announce more details soon. It will still own bonds subject to AMT in its muni high-yield and muni money market funds.

[and there was much rejoicing]

- Alec

 

[shiny]

Vanguard's Tax Managed Balanced Fund seems good with its tax efficiency.


Total Stock Market Fund also distributed 100% qualified gains, and the High Yield tax-exempt bond fund is yielding over 4% tax free (although many on this board would never buy such long bonds - Vanguard's "risky" bonds are much higher rated credit wise than other high yield bonds funds)

 

[Spanky]

I am moving $1M into Vanguard. It is non-IRA, so I am looking for advice from you pro's out there as to what funds(s) would be best to minimize taxes. I am 57 years old so I would probably be comfortable with a 65% stock-35% bonds ratio. Advice on the best bond fund to be in anyone? I am in the 39% tax bracket.
Thanks,
Jeff

Vanguard Total Stock
Inter-Term Tax-Exempt Investment

 

[Jeff55]

What does "inter - term" mean?

 

[ats5g]

What does "inter - term" mean?

It means intermediate term bonds are held in this bond fund. So, the fund is longer in maturity/duration than a MM and a Short term bond fund, but shorter in maturity/duration than a long term bond fund.

hth