Alec, no I wasn't commenting on tax efficient funds, but on funds that distribute higher eligible dividend and higher expected capital gains. Even if they are not so tax efficient, I was thinking that the tax treatment would be the overriding factor. Given cutthroats tax position, I would look at tax efficiency AND eligibility of capital gains and dividends for favorable tax treatment.
I didn't see any comments on the foreign tax credit issue above. I know that in the past I have held funds that extended such credits to me. What is the concensus of holding international funds in a taxable vs tax-deferred account? Are dividends eligible? Is the tax credit significent?
Wayne
Wayne,
Sorry for the mis-interpretation. I definitely agree that one should hold those assets that will distribute dividends that are eligible for the more favorable tax treatment. Equities certainly qualify for this, where bonds and REITs don't.
I'm just not sure that one would want to go seeking funds that will distribute a good amount of dividends or even distribute capital gains on a regular basis. I don't think you're advocating this at all. Even though a small cap fund will likely have the opportunity for higher returns, I think one still has to look for a fund (if going to be held in a taxable account) that will distribute very little dividends (qualifying or not) and very little capital gains.
I think we can agree that by using tax managed funds (like from Vanguard) or ETF's, and deferring almost all capital gains into the future, an investor would benefit from the compounding of that return. Where as if an investor had to pay more capital gains taxes yearly (even on a non-TM small cap fund), and pay taxes on the dividends yearly, he/she wouldn't benefit from said compounding as much.
Take DFA's tax-managed funds for example, especially the value funds. I believe that they have very low dividends, and specifically try to avoid those value stocks which pay high dividends. Hence, I don't think funds or ETF's like the new Dow Jones high dividend ETF (which is the highest dividend paying stocks in the DJ index if I'm not mistaken) would be optimal or better than a good tax-managed fund or value ETF, as the DJ ETF doesn't benefit from the tax-deferred compounding as much, since one would have to pay yearly taxes on those qualifying dividends. Though the dividends don't hurt as much, they still hurt.
As far the as foreign tax credit goes, I believe that the dividends from the Vanguard regional index funds and the TM int'l fund (not the funds of funds - Total int'l or Developed markets) are eligible for them, and they will be eligible for qualifying dividends lower tax treatment. Though, I'd call Vanguard to double check.
I think I might add TM small cap first, b/c of it's very low dividend yield, to the taxable account before TM int'l (since it has a much higher dividend yield). The TM growth and income, TSM, or TM capital appreciation do have lower dividend yields than TM int'l, but TM int'l does get foreign tax-credits.
I believe that I've seen the foreign tax credits adding perhaps 20-40 basis points (0.20%-0.40%) to return. Seems rather insignificant, but with future equity returns likely to be lower than "historicall", I'd take all the help I can get.
My vote: tax managed small cap fund (I vote for Vanguard here) or small cap ETF, and tax managed int'l or EAFE ETF.
- Alec