(PUB) Investing 2016

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

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. 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. Ranked by After-Tax Return 5-Year Return Tax-Adj. Return Tax- Effic.

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

Most Vanguard Funds Have Been Tax-Efficent

Ranked by After-Tax Return

5-Year Return

Tax-Adj. Return

Tax- Effic.

High Dividend Yield Idx. Social Index Growth Index U.S. Growth PRIMECAP Dividend Growth Capital Opportunity Equity Income PRIMECAP Core Growth & Income

12.6% 12.0% 95% 12.2% 11.9% 97% 11.9% 11.7% 98% 12.3% 11.6% 94% 12.2% 11.5% 94% 12.4% 11.4% 92% 12.2% 11.2% 92% 12.2% 11.2% 91% 12.0% 11.1% 93% 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%

The Independent Adviser for Vanguard Investors • May 2016 • 13

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