(PUB) Investing 2016

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

TAX EFFICIENCY Are ETFs Best on Taxes?

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 .

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

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

Odds are you’ll actually do better after taxes by staying away from ETFs and investing in an old-fashioned open-end mutual fund.

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

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.

6 • Fund Family Shareholder Association

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