Should I exchange EEM for VWO?

[figner]

During the 2008 market dip, I did some tax loss harvesting and ended up with EEM instead of VWO for my emerging markets fund. I'd prefer to hold VWO long term (for one, EEM has an Expense Ratio of .68, vs .22 for VWO), but am now "stuck" with a large capital gain in EEM in a taxable account.

Were I to sell EEM and buy VWO today, I'd be taxed about 25% on my gain (15% fed + 9% state). I do have enough carryover tax losses to offset those gains, but those carryover losses might be better applied to the annual $3k income deduction (tax bracket 28% fed, 9% state). The carryover losses would be mostly used up by offsetting the EEM sale.

Or I could just hope for another market dip to decrease those capital gains.

Any advice welcome.

 

[MichaelB]

My preference is also for VWO over EEM, but I wouldn't pay CG taxes just to exchange one for the other. Better to keep the losses and use them to offset ordinary income.

 

[LOL!]

Give away your EEM to charity and don't pay taxes on it.

 

[clifp]

I'd be inclined to sell most of the EEM, perhaps leave enough to take advantage of this years capital loss carry forward and perhaps next year.

 

[MichaelB]

I'd be inclined to sell most of the EEM, perhaps leave enough to take advantage of this years capital loss carry forward and perhaps next year.

What advantage is there to selling and buying VWO vs holding EEM? When you have unrealized gains in an investment you are getting a free ride. Part of that investment is "accrued tax" that you owe. Uncle Sam is lending it to you for fee. If the investment goes up, you only pay taxes on the additional profit. if it goes down, you lose 75% and taxes the other 25%. That's a pretty good deal.

The key is

Were I to sell EEM and buy VWO today

If this were about reducing portfolio risk, perhaps. But this is the opposite of tax loss harvesting.

 

[clifp]

Well the numbers matter here.

Let say he has $30,000 in capital loss. If he does nothing he can reduce his taxes from earned income by 3,000 * (28%-15%)= $390 for the next ten years. Of course the value of saving $390 in taxes in 2021 is considerably lower than reducing it this year. Not to mention there is chance that in 10 years the tax system capital gains will no longer be eligible for lower tax rates.

Let says figner has $200K worth of EEM that he bought for $170K, if he sells it now and buys VWO he wipes out his capital loss forward. On the other hand his expenses are reduced by 200K * (.68-. 22) = $920/year. Since $920 in reduced expenses is greater than $390 in tax saving he is better off making the swap.

Not knowing any of the details I suggested a compromise which takes advantage of a couple of years of tax losses.

However, the calculation is relatively straightforward is the reduced expense greater or less than the tax saving.

 

[MichaelB]

Well the numbers matter here.

Let say he has $30,000 in capital loss. If he does nothing he can reduce his taxes from earned income by 3,000 * (28%-15%)= $390 for the next ten years. Of course the value of saving $390 in taxes in 2021 is considerably lower than reducing it this year. Not to mention there is chance that in 10 years the tax system capital gains will no longer be eligible for lower tax rates.

Let says figner has $200K worth of EEM that he bought for $170K, if he sells it now and buys VWO he wipes out his capital loss forward. On the other hand his expenses are reduced by 200K * (.68-. 22) = $920/year. Since $920 in reduced expenses is greater than $390 in tax saving he is better off making the swap.

Not knowing any of the details I suggested a compromise which takes advantage of a couple of years of tax losses.

However, the calculation is relatively straightforward is the reduced expense greater or less than the tax saving.

Clifp, agree that without more data it is difficult. If he weren't buying back the VWO it would be a different discussion. If you look at a chart comparing EEM vs VWO, the tracking error is less than the expense difference so the savings is not supported by historical data. See here

 

[clifp]

Clifp, agree that without more data it is difficult. If he weren't buying back the VWO it would be a different discussion. If you look at a chart comparing EEM vs VWO, the tracking error is less than the expense difference so the savings is not supported by historical data. See here

I noticed that also. Generally speaking the Vanguard guys are the best in the business when it comes to tracking their indexes. For instance I've seen a couple of cases where Schwab index fund with nominal lower expenses (and commission free trading for me) than Vanguard actually lagged Vanguard by a 4 or 5 basis points. But so far that doesn't seem to be true for emerging markets.

 

[figner]

(Coming back after a couple days away from the forum)

Thanks for all your input - clifp's analysis and your comments made the issue a lot clearer for me. While I'm reluctant to post specific numbers, it looks like the long term expense ratio savings outweigh the earned income deduction after about 16 years. Since a lot can change in that timeframe (and I hope to be E-R'ed before then), I'm going to stick with EEM for now.

 

[figner]

Followup: today I sold my entire EEM position and bought VWO instead. With the recent market dip, my capital gains in EEM were reduced to the point where, adding in some other losses I was able to harvest today, it won't use up too much of my carryover tax losses. Thanks again to everyone who responded on this thread.