The Independent Adviser for Vanguard Investors
•
May 2016
•
13
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it’s just not relevant. Unbelievably,
sophisticated investors and novices
alike still seem to focus way too much
on turnover ratios (the pace at which
a fund’s holdings are traded). I can’t
tell you the number of times I’ve had
conversations with investors who were
convinced that the only way to identify
funds with high tax efficiency was to
find those that keep turnover low. That’s
old-think. Not all turnover results in
a taxable gain. Higher turnover could
mean that a fund manager is harvesting
his or her losses. Turnover is a lousy
indicator of tax efficiency.
Tax Efficiency or After-Tax
Returns?
Taking a look at the tables, there are
a few things that stand out. Large-cap
stocks, particularly those in the growth
arena, tended to perform best, both
before and after taxes were considered,
over the three- and five-year periods
through March. But take it out to seven
years (see the expanded tables on our
website), and you’ll see that smaller
and mid-cap stock funds dominated.
Again, it’s that time-dependency issue
I’ve talked about.
I alsowould note that in the large-cap-
dominated periods, many active funds,
including U.S. Growth,
PRIMECAP
and
Capital Opportunity
, topped the
list, while in the smaller- and mid-cap
periods, the tilt is more towards index
funds, though
Strategic Equity
and
Strategic SmallCap Equity
turned in
strong after-tax returns. In all cases, it
also appears that aside from one or two
outliers, the after-tax returns of the top
funds are fairly close to one another.
Also, note the continued outstand-
ing performance by Don Kilbride’s
Dividend Growth
when stacked
up against
Dividend Appreciation
Index
. His outperformance is so
strong before taxes that even after
taxes he retains a significant lead over
his index rival.
Now, one takeaway you could also
glean from this data is, for instance,
that some funds may outperform before
taxes but lose their dominance after-
wards.
Growth & Income
beat
500
Index
over the three-, five- and seven-
year periods measured here. But after
taxes, it only outperformed over five
years. That would suggest you might
want to hold the active fund in your
IRA or other tax-advantaged account
while buying 500 Index in taxable
accounts.
Again, I’m going to repeat my
admonition that these are point-in-
time calculations, so don’t use these
rankings as the sole determinant for
your fund selections. Also, and this is
important, you may not fall into the
highest category of taxpayers. So, the
difference between pre-tax and after-
tax returns could be smaller if you’re
in a lower tax bracket. You can figure
that for most of Vanguard’s funds,
after-tax returns are higher by 0.1% to
0.2% for an investor in the 28% income
tax bracket, though funds like
REIT
Index
or Convertible Securities will
see a more significant jump in after-tax
returns (on the order of 0.5% to 0.6%
or so).
Like any tool, after-tax return calcu-
lations need to be used properly, or you
might accidentally punch a hole in your
portfolio.
SectorTaxation
I’m going to save most of my com-
ments about sector funds and after-tax
returns for next month, when we’ll
cover ETFs. But let me give you a
preview: Many of Vanguard’s sector
mutual funds outperform their sector
ETF twins on an after-tax basis. The
differences can be very small, but the
fact is that the sector ETFs show no
compelling advantage on an after-tax
basis over their open-end siblings.
n
Ranked by
After-Tax Return
5-Year
Return
Tax-Adj.
Return
Tax-
Effic.
High Dividend Yield Idx.
12.6% 12.0% 95%
Social Index
12.2% 11.9% 97%
Growth Index
11.9% 11.7% 98%
Dividend Growth
12.3% 11.6% 94%
U.S. Growth
12.2% 11.5% 94%
PRIMECAP
12.4% 11.4% 92%
Capital Opportunity
12.2% 11.2% 92%
Equity Income
12.2% 11.2% 91%
PRIMECAP Core
12.0% 11.1% 93%
Growth & Income
12.0% 11.1% 92%
500 Index
11.4% 11.0% 96%
T-M Capital Appreciation 11.3% 11.0% 97%
LargeCap Index
11.1% 10.8% 97%
U.S. Value
11.3% 10.7% 95%
Strategic Equity
11.6% 10.7% 92%
Total Stock Market Index 10.9% 10.5% 96%
MidCap Value Index
10.8% 10.4% 96%
T-M SmallCap
10.4% 10.2% 98%
Value Index
10.4% 9.9% 95%
Dividend Apprec. Index 10.2% 9.8% 96%
MidCap Index
9.9% 9.6% 97%
Strategic SmallCap Equity 10.2% 9.5% 93%
Morgan Growth
10.6% 9.5% 89%
Diversified Equity
10.2% 9.3% 91%
SmallCap Value Index
9.5% 9.0% 94%
Selected Value
9.9% 9.0% 91%
Windsor
9.5% 8.7% 92%
MidCap Growth Index
8.8% 8.7% 98%
Windsor II
9.7% 8.6% 89%
SmallCap Index
8.6% 8.3% 96%
Extended Market Index
8.3% 8.0% 96%
T-M Balanced
8.1% 7.6% 94%
Explorer Value
9.0% 7.6% 84%
Balanced Index
8.1% 7.5% 92%
MidCap Growth
9.2% 7.4% 80%
SmallCap Growth Index 7.4% 7.2% 97%
Ranked by
After-Tax Return
5-Year
Return
Tax-Adj.
Return
Tax-
Effic.
Wellington
8.5% 7.1% 84%
Target Retirement 2055 7.3% 6.8% 94%
Target Retirement 2050 7.3% 6.7% 93%
Target Retirement 2040 7.3% 6.7% 92%
Target Retirement 2045 7.3% 6.7% 92%
Target Retirement 2035 7.1% 6.5% 91%
Wellesley Income
7.8% 6.4% 81%
Target Retirement 2030 6.9% 6.3% 90%
Explorer
7.9% 6.2% 79%
Global Equity
6.6% 6.2% 94%
STAR
7.1% 6.0% 85%
STAR Growth
6.8% 6.0% 89%
Target Retirement 2025 6.7% 5.9% 88%
Target Retirement 2020 6.5% 5.7% 88%
STAR Mod. Growth
6.1% 5.3% 86%
Target Retirement 2015 6.0% 5.0% 84%
Total World Stock Index
5.4% 4.9% 90%
Market Neutral
4.5% 4.5% 100%
Target Retirement 2010 5.5% 4.5% 82%
STAR Cons. Gro.
5.2% 4.2% 80%
Target Retirement Income 5.0% 4.0% 81%
Managed Payout
5.9% 3.9% 66%
International Explorer
4.5% 3.3% 75%
STAR Income
4.3% 3.2% 74%
Capital Value
4.8% 2.7% 56%
International Growth
2.5% 2.1% 83%
Pacific Index
2.6% 2.0% 74%
Developed Mkts. Index
2.5% 1.8% 74%
Convertible Securities
3.6% 1.6% 43%
European Index
2.3% 1.5% 65%
International Value
1.3% 0.7% 55%
World ex-US SmCap Idx.
1.1% 0.4% 32%
Total International Index 0.6% -0.2% Neg.
World ex-US Index
0.4% -0.3% Neg.
Emerging Markets Index -4.3% -5.0% Neg.
Most Vanguard Funds Have Been Tax-Efficent