(PUB) Investing 2016

hit the funds with a heavy tax burden, applying a 20% capital gains rate and a 43.4% income tax rate, which incor- porates the 3.8% health-care surtax on high-income-earners. For qualified dividend income, as specified under the American Taxpayer Relief Act of 2012, I’ve used the percentages reported by Vanguard for each individual fund. The funds in the tables are ranked by after- tax returns. My one caveat here is the same as I note when discussing roll- ing returns versus static performance calculations: These after-tax returns are based on point-in-time calculations for the single three-year and five-year peri- ods ending in March. Why does that matter? I’ll explain in a moment. One fund characteristic that I haven’t bothered to look at is turnover, because Target Retirement 2055 7.0% 6.6% 93% SmallCap Growth Index 6.8% 6.5% 96% Target Retirement 2050 7.1% 6.5% 92% Target Retirement 2040 7.1% 6.5% 92% Target Retirement 2045 7.1% 6.5% 91% Explorer Value 7.9% 6.4% 80% Target Retirement 2035 7.0% 6.3% 89% Wellington 7.8% 6.1% 79% Target Retirement 2030 6.7% 6.0% 89% STAR Growth 6.7% 5.9% 88% Market Neutral 5.9% 5.9% 100% Target Retirement 2025 6.3% 5.5% 87% Explorer 8.0% 5.4% 68% STAR 6.5% 5.3% 82% Target Retirement 2020 6.0% 5.2% 87% Total World Stock Index 5.7% 5.2% 90% STAR Mod. Growth 5.8% 5.0% 85% Wellesley Income 6.0% 4.5% 75% Target Retirement 2015 5.3% 4.2% 80% STAR Cons. Gro. 4.8% 3.8% 79% Target Retirement 2010 4.4% 3.4% 77% Managed Payout 5.6% 3.2% 58% STAR Income 3.8% 2.8% 75% Target Retirement Income 3.6% 2.8% 76% International Growth 3.1% 2.7% 86% European Index 2.9% 2.1% 73% Developed Mkts. Index 2.4% 1.9% 78% World ex-US SmCap Idx. 2.5% 1.7% 69% Capital Value 5.0% 1.7% 34% Convertible Securities 3.5% 1.2% 36% International Value 1.3% 0.7% 58% Pacific Index 1.0% 0.4% 40% Total International Index 0.7% -0.0% Neg. World ex-US Index 0.6% -0.2% Neg. Emerging Markets Index -4.5% -5.4% Neg. EmergingMkts Sel. Stock -5.2% -5.6% Neg. Ranked by After-Tax Return 3-Year Return Tax-Adj. Return Tax- Effic.

the investor’s goal should not be to “minimize capital gains” but rather to “maximize after-tax wealth.” Unfortunately, Joel’s wisdom doesn’t always percolate down to those offer- ing up advice to the masses. Tax effi- ciency tells you nothing about a fund’s returns—it only tells you the portion of that fund’s returns you’re likely to keep. Before you check out the table sum- maries below and on page 13, let’s define our parameters, and let me give you a caveat. Both the returns and tax-efficiency calculations I’ve done cover the three- and five-year periods ending March 31, 2016. (An expanded set of tables, including a seven-year table, is provided in the HTML ver- sion of the issue at our members-only website, www.adviseronline.com.) I’ve 13.0% 11.8% 91% T-M Capital Appreciation 11.6% 11.3% 97% 500 Index 11.7% 11.2% 96% Morgan Growth 12.8% 11.0% 86% LargeCap Index 11.4% 11.0% 97% Growth & Income 12.2% 11.0% 90% Dividend Growth 11.8% 10.9% 92% High Dividend Yield Index 11.2% 10.6% 94% Total Stock Market Index 11.0% 10.6% 96% Strategic Equity 11.9% 10.6% 89% MidCap Value Index 10.9% 10.5% 96% MidCap Index 10.6% 10.3% 97% T-M SmallCap 10.5% 10.2% 97% Value Index 10.4% 9.9% 95% MidCap Growth Index 9.9% 9.7% 98% Equity Income 10.7% 9.4% 87% Strategic SmallCap Equity 10.3% 9.3% 91% Diversified Equity 10.6% 9.2% 87% U.S. Value 9.9% 9.2% 93% Dividend Apprec. Index 9.5% 9.1% 96% SmallCap Value Index 9.4% 8.9% 95% Selected Value 9.3% 8.2% 87% SmallCap Index 8.4% 8.0% 95% Windsor 8.8% 7.8% 88% Extended Market Index 8.0% 7.6% 96% Windsor II 8.5% 7.0% 82% Balanced Index 7.6% 7.0% 92% T-M Balanced 7.4% 7.0% 94% MidCap Growth 9.2% 6.7% 73% International Explorer 8.1% 6.7% 83% Target Retirement 2060 7.1% 6.6% 94% Global Equity 6.9% 6.6% 95% Ranked by After-Tax Return 3-Year Return Tax-Adj. Return Tax- Effic. U.S. Growth PRIMECAP 13.5% 12.3% 91% 13.5% 12.2% 91% 13.2% 12.2% 93% 12.4% 12.2% 98% 12.4% 12.1% 97% Capital Opportunity Growth Index Social Index PRIMECAP Core

TALES FROM PAGE 7 >

efficiency for a moment. Or, better yet, let’s talk about after-tax returns. As I said, tax efficiency often gets the headlines, but it’s really not the most important metric for assessing the overall performance of a fund when taxes are your concern. For years I’ve said that just because many index funds are tax efficient and have low turnover, that doesn’t mean they’ll make you richer faster. Vanguard, like so many other asset managers, talks tax efficiency and after- tax returns, but in the same breath, advises that investors keep index funds in taxable accounts and active funds in tax-deferred accounts like IRAs. What they’re doing is dumbing down the advice they share with investors, falling back on letting their tax tale wag the investment advice dog. Here’s Vanguard’s latest pitch: “Investors should maximize the tax efficiency of their portfolio because taxes have the potential for taking the biggest bite out of investment returns over the long run.” In fact, they often trot out the hack- neyed advice that you can potentially improve your returns by keeping less tax- efficient funds in tax-deferred accounts. Of course, you could also improve your returns by buying better funds—but that isn’t part of the Vanguard mantra. I can understand why they take this route. Vanguard doesn’t want you to know that there’s another way to look at fund performance or tax efficiency, and they certainly aren’t going to provide their investors with the data to make up their own minds. Hence, the simple, contrived and often wrong advice. I have to say that I was encour- aged some years ago when Vanguard began to note that focusing on a low turnover rate as the key to fending off distributions was a “flawed” approach. Vanguard tax maven Joel Dickson, who also happens to help run the quantitative side of Vanguard’s stock shop, even said, “At the end of the day, the question is whether you have created wealth, not how much you have reduced taxes.” As he’s put it,

After-Tax Returns Over Tax-Efficiency

12 • Fund Family Shareholder Association

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