6
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Fund Family Shareholder Association
www.adviseronline.comindex absolutely outperformed, hit-
ting an MCL (Maximum Cumulative
Loss) of -52.2% compared to the CRSP
index’s -58.7% MCL. But over other
down-market periods, the S&P index
didn’t do any better, and sometimes it
did worse than the CRSP index, so it’s
closer to a toss-up on the risk side.
One other factor that I think is worth
noting is that the companies in the S&P
index are much smaller than those in
the CRSP index. The median company
in the S&P index is currently $3.8 bil-
lion in size, while the median CRSP
index company weighs in at $10.2
billion. To my way of thinking, we’re
getting more mid-caps and maybe a
few smaller companies in the portfolio
than the CRSP index offers. Plus, the
companies in the S&P index are chosen
by a committee of humans, not comput-
ers. Don’t forget that. So we’re actually
choosing to side with an actively man-
aged index rather than a computer-man-
aged one. How’s that for an oxymoron?
In any case, that’s some of the analy-
sis that Jeff and I went through in mak-
ing this decision, which was something
we thought long and hard about.
Action Items
So, in sum, as noted in the April 28
Hotline
, Jeff and I think it’s the right
move to trade out of
SelectedValue
and
into
S&P Mid-Cap 400 Value ETF
.
Some of you will have large gains in
Selected Value and will be wary of tak-
ing the tax hit. I get that. One alterna-
tive is to stop reinvesting in Selected
Value and direct your new money and
distributions into the S&P ETF.
Others of you may wish to stick with
open-end mutual funds and not buy an
ETF at all. I can understand that, though
it doesn’t cost anything to buy an ETF if
your account’s at Vanguard. But if you
decide you simply won’t buy an ETF,
or it’s not available in your 401(k) plan,
there’s nothing wrong with MidCap
Value Index. In the end, I think the dif-
ferences over time will be small.
But in the
Model Portfolios,
we’ve
sold Selected Value and bought S&P
MidCap 400 Value ETF.
n
>
THOSE MASSIVE LOSSES
“earned”
during the financial crisis and linger-
ing in our mutual funds’ portfolios are
(for the most part) long gone now that
we’re seven years into this bull market.
Other than
Precious Metals & Mining
,
which is sitting on realized and unreal-
ized losses equal to an astounding 105%
of its portfolio value (yes, really!), and a
number of international stock funds that
haven’t seen the massive run-ups of their
domestic counterparts, most funds are
sitting on unrealized gains—capital gains
in stocks that haven’t been sold yet.
That’s why it’s a good time to think,
once again, about taxes and, more impor-
tantly, the concept of tax efficiency. You
see, what many investors think they
know about taxes and mutual funds is, in
many cases, dead wrong. Now’s the time
to give this a thorough look-see and to
strike down the accepted wisdom.
Now that Tax Day has passed, there’s
little you or I can do about what hap-
pened in 2015. But as the tax reporting
deadline fades, I can fully appreciate
you might be wondering how to reduce
or even eliminate future tax bills.
But that’s not the way to think about
it. Indulge me for a moment. The goal
of investing isn’t to avoid taxes, but
to maximize wealth after you’re done
paying your taxes. Keeping an eye on
the taxes you pay certainly should be a
factor in your investment strategy, but
it’s not the whole story.
As I’ve noted in years past, most of
Vanguard’s funds have been quite good
at shielding a majority of their share-
holders’ returns from the IRS, earning
high marks for tax efficiency. While
this was largely thanks to big losses
realized during the bear market, it’s
also a testimony to smart and selective
selling by some of the funds’ managers
and their long-term investment style, as
they have not yet “realized” the gains
they’ve been building for us.
Still, as I’ve said many times before,
focusing on tax efficiency is the wrong
way to look at the bite taxes take out of
your investments. You want to focus on
after-tax returns.
I often say that the focus on tax effi-
ciency can lead you down the wrong
path. For instance, a couple of years
ago, I noted that
U.S. Growth
was
Vanguard’s single most tax-efficient
fund over the three years ending in
2013, as the portfolio managers took
advantage of millions in realized losses,
having not paid out capital gains since
2000. I also said those losses were pret-
ty much used up, and to expect capital
gains in 2014. Bingo! That’s exactly
what happened, and what had been the
most super-tax-efficient fund all of a
sudden wasn’t.
Today, Vanguard’s most tax-efficient
fund is
Market Neutral
. The fund
barely pays out a distribution, and when
it does, it’s fractional. So, investors
here get to keep almost every dollar
they earn. The problem is, they don’t
earn that much. So why would we use
a close to 100% tax-efficiency measure
to choose an investment? Well, you
wouldn’t, or at least you shouldn’t.
Focusing on tax efficiency is like focus-
ing on the top-performing fund over the
most recent three years or the last six
months—meaningless, absent context.
Plus, how do you really distinguish
between funds when so many have
similar tax efficiency ratios? In any
given three- or five-year period, better
than half of Vanguard’s funds, whether
indexed or actively managed, typically
show tax-efficiency rates of 90% or
better. That means investors kept 90%
or more of the funds’ returns even after
paying taxes. So that’s not a very dis-
cerning metric for picking funds.
TAX EFFICIENCY
After-Tax Tales