Investing question regarding placement for small cap ETF

[joecaf53]

I was looking to make some changes to my portfolio and would like some advice.

I was thinking of purchasing a small blend ETF in my taxable portfolio and narrowed my choices between IJR and SLY. IJR has a turnover ratio of 18% vs SLY of 82% and IJR has a slightly better tax cost ratio, although SLY has returned a little more over a 5 year period with a little more risk.

I thought that ETF's work best in taxable accounts, but that high turnover funds belong in tax deferred.

Being this is small cap, where is the best place for these funds?

Thanks,

Joe

 

[panacea]

Generally small caps are best held in retirement accounts because good small companies can become mid-caps, creating turnover. Otherwise, have you considered the Vanguard tax-managed small cap fund (VTMSX)? It has the expense ratio of a typical ETF with better than average performance.

 

[joecaf53]

Panacea,

I didn't think of VTMSX, I will look into this. Thanks

 

[Animorph]

I keep a balance between taxable and retirement accounts. So for me the answer is generally some in both accounts.

That said, if taxable distributions on these are worse than your most of the funds in your taxable account then you might consider placing it in your retirement account instead. If your tax rates are lower than those used to calculate the tax cost ratio, then SLY might look a little better. I have had a few of these types of funds come in with large distributions in one year, so the retirement account might offer some safety against that uncertainty. Check the potential capital gains exposure to see if either one might be primed for a large distribution.

 

[LOL!]

You are overthinking this. One cannot look at the tax-cost ratio in isolation. The Morningstar tax-cost ratio may not even be correct and may not apply to your tax bracket, especially if you have tax-loss harvesting things going on.

Please compare to a tax-efficient fund like a Total Stock Market Index fund. One cannot get down to zero if the fund pays any dividends. The difference between a small-cap fund and the TSM is insignificant.

Here's the best place to read about all this (and note the tables in this link with clickable presentations):
Principles of Tax-Efficient Fund Placement - Bogleheads

Generally, small-cap index funds are very tax-efficient nowadays. Growth funds are more tax-efficient than value funds, but not significantly more-so.

And finally, ETFs are no more tax-efficient than similar mutual funds. That is, passively-managed index funds will be more tax-efficient than actively-managed funds.

 

[veremchuka]

I thought that ETF's work best in taxable accounts, but that high turnover funds belong in tax deferred.

Being this is small cap, where is the best place for these funds?

Thanks,

Joe

I don't see why an ETF works best in a taxable account. Small caps are best held in a tax deferred or Roth as they are tax inefficient.

 

[LOL!]

Once again, small cap index funds are NOT tax-inefficient. They are rather tax-efficient as shown in the link I gave.

 

[veremchuka]

Once again, small cap index funds are NOT tax-inefficient. They are rather tax-efficient as shown in the link I gave.

Thanks for this info! I have read, though not sure where as I read a lot of different places, that the most tax inefficient funds are (not in order) high yield bonds, REITS, TIPS and small cap and are best kept in other than a taxable account. The reason is that they generate a lot of dividends. I will have to remember that small cap is not in this group.

 

[Gotadimple]

Thanks for this info! I have read, though not sure where as I read a lot of different places, that the most tax inefficient funds are (not in order) high yield bonds, REITS, TIPS and small cap and are best kept in other than a taxable account. The reason is that they generate a lot of dividends. I will have to remember that small cap is not in this group.

It is not small cap that is the issue. It is the difference between an actively managed mutual fund and an index fund or index etf. Actively managed mutual funds can have high turnover, especially if they focus on small caps, thus they create taxable income. An index fund is designed to be tax efficient and can be held in a taxable account.

-- Rita

 

[veremchuka]

Yes that makes perfect sense. Actively managed funds would have the potential to generate more taxable gains due to their frequent trading than an index fund. Thanks for the clarification.