(PUB) Investing 2016

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6 • Fund Family Shareholder Association
snafus at Vanguard that readers have
reported to Dan and me over the years.
Or how about the report that in February
Vanguard sent 71 emails to a share-
holder detailing transactions of other
Vanguard shareholders ranging from $3
to more than $50,000?
Sometimes you do get what you
pay for.
As I said at the get-go, I’m not out
to give Vanguard a black eye, nor am I
about to give up on Vanguard. Vanguard
provides us access to some of the best
investment minds in the business at
rock-bottom prices—for that, we can
all be thankful. But even when it comes
to Vanguard—whether it’s their market
materials, advice from Vanguard on
how to invest or just regularly review-
ing your statements—keep a skeptical
eye about you. Dan and I will be. n
MANY OF VANGUARD’S open-end
mutual funds are very tax efficient, as
I detailed for you last month. But what
about the vaunted tax efficiency of
exchange-traded funds—in particular,
Vanguard’s?
As I’m sure you know, ETFs have
long been touted as the most tax-effi-
cient way to invest. It’s one of the ETF
industry’s calling cards.
However, many years ago I showed
you some preliminary data to indicate
that ETFs might not be any better at
keeping taxes at bay than a regular old
open-end index fund. In fact, I told you
that in some cases, the old format was
better than the new.
Well, with several more years of
data now available, I’d say neither
vehicle has proven superior. From an
investor’s tax perspective, over specific
time periods, many of Vanguard’s ETFs
have a teeny-tiny advantage over their
open-end index fund siblings. But some
don’t. And the differences are minor.
Getting right to the data, in the table
on page 7, I’ve grouped sibling ETFs
and index funds, with the ETF listed
first. I’ve used Vanguard’s Investor
shares to represent the open-end fund to
give the ETFs as much of an advantage
as possible.
Running down the table, you’ll see
that many times, on an after-tax basis,
the ETF comes out slightly ahead of its
Investor share sibling. At other times,
particularly among Vanguard’s sector
fund portfolios, it’s the mutual fund
in front. Most importantly, the differ-
ences are measured in basis points, or
hundredths of a percent. Now, imagine
the extra 10 or so basis-point advantage
in operating expenses of the Admiral
share class versus the Investor share
class, and you’ll quickly conclude that
the old, tried-and-true open-end fund
is probably just as good as the ETF, if
not better.
It’s really a toss-up.
So, if you hear someone extolling the
tax-efficiency advantage of a Vanguard
ETF over a Vanguard index fund, pull
this table out. The argument may hold a
little water, but it’s pretty leaky.
Now, a couple of things to point out.
First off, remember that ETF returns
are dynamic in that not everyone gets
the same price when they buy or sell
or even just read their month-end state-
ments to check prices and performance,
particularly if you use multiple brokers.
When I report Vanguard’s ETF returns,
I’m using real-world prices. I own
shares in every Vanguard ETF, so I
use the prices I receive in my personal
Vanguard account for things like rein-
vestment, to give you the most accu-
rate data I can. Still, each individual’s
returns could be better or worse than
what I’m reporting.
Plus, as I said, if you buy the
Admiral shares instead of Investor
shares, my original comment holds:
The odds are that you’ll actually do
better after taxes by staying away
from ETFs and investing in an old-
fashioned open-end mutual fund.
I’ll let you look at the table yourself,
but one thing to note: I’ve compared
returns for the Tax-Managed funds
against their respective benchmark
index ETFs. Tax-Managed Capital
Appreciation, which tracks the Russell
1000 index, but makes tactical moves
to reduce taxes, outperformed Russell
1000 ETF by an annualized 0.2% over
the three- and five-year periods end-
ing in March. Similarly, Tax-Managed
SmallCap, which traces the S&P
SmallCap 600 Index, did about the
same against S&P SmallCap 600 ETF.
Also, one comparison that I’ve talk-
ed about before is in the health care
sector, which has been super strong
these past several years. Health Care’s
returns have been good, as have those
of Health Care Index and Health
Care ETF. Yet, after you take taxes
into account—and remember, I’m hit-
ting the funds with the top tax rates—
the index fund comes out ahead over
five years, while the active fund wins
over three. But please notice the differ-
ence in “tax efficiency,” which runs in
the high 80s for the active fund but in
the high 90s for the index options, and
remember what I’ve long said about tax
efficiency: It isn’t the tax efficiency but
the after-tax return that matters. Health
Care is a good example of that.
You might be wondering why after-
tax returns are so similar over the
TAX EFFICIENCY
Are ETFs Best on Taxes?
Odds are you’ll actually do better after taxes by
staying away from ETFs and investing in an
old-fashioned open-end mutual fund.
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