Target date funds ... so much for "set and forget" [and WSJ article]

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lasater
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Target date funds ... so much for "set and forget" [and WSJ article]

Post by lasater »

[The Wall Street Journal article starts at this post --admin LadyGeek]

Hey all,

I've been investing all my taxable and tax-advantaged assets in Vanguard's 2040 target date fund VFORX. I just learned a hard lesson about the tax efficiency of this fund, and am looking for guidance on improving my asset location strategy, and general approach to investing.

By way of background, I didn't start saving for retirement until my early 30s. (... I really wish I could go back in time and give the younger me a stern talking to about compound interest ... not sure he would listen though!!) Around 2011, I finally wised up to long-term investing, and the Bogleheads philosophy resonated with me. A target retirement date fund seemed the easiest way to get started, and I decided to invest in VFORX. I opened my first 401(k) that year and have made the maximum contribution every year since. The total balance in my tax-advantaged accounts at this point is about 260K.

I work in tech, and was fortunate to experience significant equity upside in a startup. In 2020 I realized ~4.8M in net proceeds through a secondary share sale, and decided to take the same approach to managing these funds versus paying a wealth advisor to manage them for me. I invested all the proceeds in VFORX (held in a regular taxable brokerage account.)

As of 12/28/2021, I had a 6.4M balance in this brokerage account, with 1.6M of unrealized LT gains. As as been discussed in several other threads, VFORX and many other Vanguard target date funds made huge capital gains distributions in 2021, and as a result I unexpectedly and undesirably received ~1.0M of capital gains distributions on 12/29/2021, thus creating a huge tax bill for 2021 :-/

I'm pretty annoyed at myself for not being more educated about how to select funds for taxable accounts (and/or choosing a wealth advisor who hopefully would have made smarter decisions), and at Vanguard (...who I think could have done a far better job of educating investors on this issue/risk.)

I live in NYC and already have W-2, STCG and non-qualified dividend income of about 380K, so will hit the 20% bracket on most of the LTCG, as well as paying a further 3.8% NIIT and 8.82% state. All told, the timing of the distribution means I will pay 34% on 1M of LTCG, versus the 10-25% a more intentional strategy would have afforded. I appreciate this story might earn me a song played on the worlds smallest violin, but nonetheless it's hardly smart investing which is why I'm asking for advice :)

One silver lining is that with the reduced basis I have an opportunity to reallocate up to 4M of VFORX held in the brokerage account without incurring much additional LTCG in 2022. I'm now debating between getting a professional to manage my taxable assets, or continuing to manage them myself, probably by creating a three fund portfolio using more tax efficient funds (e.g., VTI for equities).

I'd appreciate any guidance the more experienced Bogleheads out there might have :) Candidly the experience above has dented my confidence in managing my own portfolio.

Thanks!
livesoft
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Re: Target date funds ... so much for "set and forget"

Post by livesoft »

Since you know what is held inside your target date fund, then you can semi-duplicate it any time you want to. However, selling shares of your target date fund out of your taxable account could be problematic for you.

a. Do not reinvest distribution in your taxable.. If you reinvested the recent distribution consider selling just those shares before they go up or down in value. Instead use the distribution money to buy more tax-efficient investments.

b. In your situation, if you need bonds in your taxable account, then consider tax-exempt muni bonds, either National tax-exempt or Triple-NY-tax-exempt.

c. Move away from your high tax location and stop working. These two things will definitely reduce any future tax burdens that you might have.
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JBTX
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Re: Target date funds ... so much for "set and forget"

Post by JBTX »

So a $6 million investment in a target date fund has $1 million in distributions in 2021??
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David Jay
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Re: Target date funds ... so much for "set and forget"

Post by David Jay »

Welcome to the forum!

We have a pretty complete financial Wiki, for instance here is the page on tax-efficient fund placement: https://www.bogleheads.org/wiki/Tax-eff ... _placement

And yes, at your asset level I would avoid Target Date funds and instead place the constituent parts (switching to tax-exempt bonds as necessary) into the optimum locations.
Last edited by David Jay on Mon Jan 03, 2022 10:47 am, edited 1 time in total.
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livesoft
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Re: Target date funds ... so much for "set and forget"

Post by livesoft »

JBTX wrote: Mon Jan 03, 2022 10:42 am So a $6 million investment in a target date fund has $1 million in distributions in 2021??
A $6.4 million investment in VFORX had about $1 million in capital gains distributions for 2021. In addition to the capital gains distribution, there was also a dividend distribution so the distributions were more than $1 million.
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livesoft
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Re: Target date funds ... so much for "set and forget"

Post by livesoft »

I am very interested how the OP came to find Bogleheads.org forum, decide to join, and post. What's the story there? Long-time reader or not?

Welcome.
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billfromct
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Re: Target date funds ... so much for "set and forget"

Post by billfromct »

According to the Vanguard website, the 2040 Target Retirement Fund had a $8.69 payout with a 12/28/2021 record date. The price on 12/28/2021 was $50.77, so based on my math, that would be a 17.1% payout.


bill
JBTX
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Re: Target date funds ... so much for "set and forget"

Post by JBTX »

livesoft wrote: Mon Jan 03, 2022 10:45 am
JBTX wrote: Mon Jan 03, 2022 10:42 am So a $6 million investment in a target date fund has $1 million in distributions in 2021??
A $6.4 million investment in VFORX had about $1 million in capital gains distributions for 2021. In addition to the capital gains distribution, there was also a dividend distribution so the distributions were more than $1 million.
Wow.
ThisTooShallPass123
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Re: Target date funds ... so much for "set and forget"

Post by ThisTooShallPass123 »

The wiki shows Approximate Tax Efficiency Ranking for Major Asset Classes, and includes:
Efficient
  • Low-yield money market, cash, short-term bond funds
  • Tax-managed stock funds
  • Large-cap and total-market stock index funds
  • Balanced index funds
  • Small-cap or mid-cap index funds
  • Value index funds
Moderately inefficient
  • Moderate-yield money market, bond funds
  • Total-market bond funds
  • Active stock funds
Very inefficient
  • Real estate or REIT funds
  • High-turnover active funds
  • High-yield corporate bonds
Questions:
  • Where in the list is a Target Retirement fund?
  • Is something like the Vanguard Balanced Index Fund (VBIAX) considered "efficient" (i.e., isn't it a "balanced index fund")? Doesn't it have the same issue as the Target fund?
Peripatetic Investor
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Re: Target date funds ... so much for "set and forget"

Post by Peripatetic Investor »

I would move cash dividends (and any stock with low BIG) to VTI, VXUS, and, for bond portion of your portfolio, munis and iBonds. I believe Vanguard has a NY-specific tax exempt fund you might want to consider. If you want exposure to taxable bonds, they should be moved into tax-deferred accounts. I made a similar (but much smaller in scope) mistake by investing in VBIAX (balanced fund) in my taxable account. I have low 6-digits in that fund, but it has significant gain (much of it was purchased during the COVID bear). So, to "unwind" the mistake, (1) I have turned off automatic dividend reinvestment and (2) I will use VBIAX shares to make charitable donations and contribute to an UTMA (where it can be tax-gain harvested for the benefit of my child). Also, if I ever did have to draw down from my portfolio for living expenses, I'd probably just bite the bullet and sell those suckers.
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Peripatetic Investor
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Re: Target date funds ... so much for "set and forget"

Post by Peripatetic Investor »

ThisTooShallPass123 wrote: Mon Jan 03, 2022 11:42 am
Questions:
  • Where in the list is a Target Retirement fund?
  • Is something like the Vanguard Balanced Index Fund (VBIAX) considered "efficient" (i.e., isn't it a "balanced index fund")? Doesn't it have the same issue as the Target fund?
See my post below. VBIAX is not tax efficient. I also don't understand why they have small cap funds as tax efficient -- I place those only in tax-advantaged accounts. My taxable account, once I eliminate the VBIAX, will be entirely VTI, VXUS, and munis. Even more efficient would be to separate VTI into large growth (VUG) in the taxable account and, if you have adequate tax-advantaged space, move small value (VBR) there.
"The answer to the ultimate question of life, the universe, and everything is....42" -- Hitchhiker's Guide to the Galaxy
ThisTooShallPass123
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Re: Target date funds ... so much for "set and forget"

Post by ThisTooShallPass123 »

garyscan wrote: Mon Jan 03, 2022 11:50 am I made a similar (but much smaller in scope) mistake by investing in VBIAX (balanced fund) in my taxable account.
Same thing happened to me! (Hence my questions above) The tax-efficient fund wiki (https://www.bogleheads.org/wiki/Tax-eff ... _placement) does suggest these are "Efficient" asset classes and can be placed in any account. At least this is how I read it...that the "Vanguard Balanced Index Fund" is a "balanced index fund".
Peripatetic Investor
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Re: Target date funds ... so much for "set and forget"

Post by Peripatetic Investor »

ThisTooShallPass123 wrote: Mon Jan 03, 2022 11:57 am
garyscan wrote: Mon Jan 03, 2022 11:50 am I made a similar (but much smaller in scope) mistake by investing in VBIAX (balanced fund) in my taxable account.
Same thing happened to me! (Hence my questions above) The tax-efficient fund placement wiki does suggest these are "Efficient" asset classes and can be placed in any account. At least this is how I read it...that the "Vanguard Balanced Index Fund" is a "balanced index fund".
Clearly "efficiency" is a spectrum. It's like a "low-cost" mutual fund. I would consider VBIAX inefficient, but definitely not as inefficient as a bond fund. In any case, what's the difference between VBIAX and the life strategy fund?
"The answer to the ultimate question of life, the universe, and everything is....42" -- Hitchhiker's Guide to the Galaxy
tashnewbie
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Re: Target date funds ... so much for "set and forget"

Post by tashnewbie »

ThisTooShallPass123 wrote: Mon Jan 03, 2022 11:57 am
garyscan wrote: Mon Jan 03, 2022 11:50 am I made a similar (but much smaller in scope) mistake by investing in VBIAX (balanced fund) in my taxable account.
Same thing happened to me! (Hence my questions above) The tax-efficient fund wiki (https://www.bogleheads.org/wiki/Tax-eff ... _placement) does suggest these are "Efficient" asset classes and can be placed in any account. At least this is how I read it...that the "Vanguard Balanced Index Fund" is a "balanced index fund".
One of the component parts of VBIAX is a total market bond fund which the wiki says is "moderately inefficient". It might be worthwhile for the wiki to be updated to change the placement of "balanced index fund" and add target date funds. The tax efficiency obviously depends on someone's specific tax situation.
pingo
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Re: Target date funds ... so much for "set and forget"

Post by pingo »

garyscan wrote: Mon Jan 03, 2022 12:02 pm
ThisTooShallPass123 wrote: Mon Jan 03, 2022 11:57 am
garyscan wrote: Mon Jan 03, 2022 11:50 am I made a similar (but much smaller in scope) mistake by investing in VBIAX (balanced fund) in my taxable account.
Same thing happened to me! (Hence my questions above) The tax-efficient fund placement wiki does suggest these are "Efficient" asset classes and can be placed in any account. At least this is how I read it...that the "Vanguard Balanced Index Fund" is a "balanced index fund".
Clearly "efficiency" is a spectrum. It's like a "low-cost" mutual fund. I would consider VBIAX inefficient, but definitely not as inefficient as a bond fund. In any case, what's the difference between VBIAX and the life strategy fund?
As a side note, when I think of a single balanced/asset allocation fund for a taxable account, I always think in terms of the Vanguard Tax-Managed Balanced Index Fund (VTMFX) ER 0.09%.
singletonjack
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Re: Target date funds ... so much for "set and forget"

Post by singletonjack »

I am in the same boat as so many on this Vanguard distribution for target retirement date funds (I had both the 2030 and 2040). A google search led me to this forum - and I was quite pleased to discover this site and the contents! I spent the majority of my career in Wall Street as an analyst on the buy & sell-side. I look forward to discussions & making contributions here.
dcare
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Re: Target date funds ... so much for "set and forget"

Post by dcare »

Most of my Vanguard funds are in tax sheltered accounts and I don't worry too much about capital gains/dividends. Even so, I do watch for and monitor the Final estimated year-end distributions - Vanguard Advisors - https://advisors.vanguard.com/insights/ ... tributions
which this year was updated on Dec 9th and listed Target Retirement 2040 VFORX 12/28/21 12/29/21 12/30/21 68% $1.02 $0.14 $7.53 $7.67 15.55%.
This would give you time to act if necessary.
nolesrule
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Re: Target date funds ... so much for "set and forget"

Post by nolesrule »

ThisTooShallPass123 wrote: Mon Jan 03, 2022 11:42 am The wiki shows Approximate Tax Efficiency Ranking for Major Asset Classes, and includes:
Efficient
  • Low-yield money market, cash, short-term bond funds
  • Tax-managed stock funds
  • Large-cap and total-market stock index funds
  • Balanced index funds
  • Small-cap or mid-cap index funds
  • Value index funds
Moderately inefficient
  • Moderate-yield money market, bond funds
  • Total-market bond funds
  • Active stock funds
Very inefficient
  • Real estate or REIT funds
  • High-turnover active funds
  • High-yield corporate bonds
Questions:
  • Where in the list is a Target Retirement fund?
  • Is something like the Vanguard Balanced Index Fund (VBIAX) considered "efficient" (i.e., isn't it a "balanced index fund")? Doesn't it have the same issue as the Target fund?
It's a list of major asset classes, not a list of funds that are a composite of multiple asset classes and must maintain a specified asset allocation regardless of market performance. Any fund that must rebalance between asset classes to maintain an allocation will always have the possibility of tax inefficiency. It's no different than an individual having to rebalance in a taxable account.
Peripatetic Investor
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Re: Target date funds ... so much for "set and forget"

Post by Peripatetic Investor »

pingo wrote: Mon Jan 03, 2022 12:08 pm
As a side note, when I think of a single balanced/asset allocation fund for a taxable account, I always think in terms of the Vanguard Tax-Managed Balanced Index Fund (VTMFX) ER 0.09%.
Thanks, pingo. Looks like VTMFX swaps out the taxable bonds for tax-exempt bonds. Nice.
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ThisTooShallPass123
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Re: Target date funds ... so much for "set and forget"

Post by ThisTooShallPass123 »

garyscan wrote: Mon Jan 03, 2022 12:02 pm
ThisTooShallPass123 wrote: Mon Jan 03, 2022 11:57 am
garyscan wrote: Mon Jan 03, 2022 11:50 am I made a similar (but much smaller in scope) mistake by investing in VBIAX (balanced fund) in my taxable account.
Same thing happened to me! (Hence my questions above) The tax-efficient fund placement wiki does suggest these are "Efficient" asset classes and can be placed in any account. At least this is how I read it...that the "Vanguard Balanced Index Fund" is a "balanced index fund".
Clearly "efficiency" is a spectrum. It's like a "low-cost" mutual fund. I would consider VBIAX inefficient, but definitely not as inefficient as a bond fund. In any case, what's the difference between VBIAX and the life strategy fund?
The underlying bond fund isn't kicking off crazy capital gains. It does seem the balanced fund is more inefficient.

As for the difference between the balanced fund and the life strategy - it's domestic vs. international.
pingo
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Re: Target date funds ... so much for "set and forget"

Post by pingo »

garyscan wrote: Mon Jan 03, 2022 12:23 pm
pingo wrote: Mon Jan 03, 2022 12:08 pm
As a side note, when I think of a single balanced/asset allocation fund for a taxable account, I always think in terms of the Vanguard Tax-Managed Balanced Index Fund (VTMFX) ER 0.09%.
Thanks, pingo. Looks like VTMFX swaps out the taxable bonds for tax-exempt bonds. Nice.
Also, it is not a fund of funds, so rebalancing between stocks and bonds is managed differently than a target fund.

It also focuses it's stocks with no dividends, qualified dividends, etc. [Edited:] and tax exempt bonds.

At least as of 2016, the fund hadn't even made a single capital gains distribution since 1994.

Source: Morningstar.com article: A Superior Tax-Conscious Balanced Fund From Vanguard
Last edited by pingo on Mon Jan 03, 2022 2:19 pm, edited 2 times in total.
HeelaMonster
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Re: Target date funds ... so much for "set and forget"

Post by HeelaMonster »

garyscan wrote: Mon Jan 03, 2022 11:50 am .... So, to "unwind" the mistake, (1) I have turned off automatic dividend reinvestment...
Am I correct in thinking that this step (turn off auto reinvestment) will only help to the extent that future payouts will not be even higher, because they would be based on a continually growing number of shares? In other words, if the exact same percent distribution was made next year, the resulting payout (and resulting tax problem) would be identical, but at least wouldn't be any larger. But that it doesn't do anything to unwind the current situation, since you'd still be stuck with that number of shares?

I'm sure this is a "duh" question. Just trying to make sure that I am not overlooking (or underestimating) the impact of turning off reinvestment.
dbr
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Re: Target date funds ... so much for "set and forget"

Post by dbr »

HeelaMonster wrote: Mon Jan 03, 2022 1:36 pm
garyscan wrote: Mon Jan 03, 2022 11:50 am .... So, to "unwind" the mistake, (1) I have turned off automatic dividend reinvestment...
Am I correct in thinking that this step (turn off auto reinvestment) will only help to the extent that future payouts will not be even higher, because they are based on a continually growing number of shares? In other words, if the exact same percent distribution was made next year, the resulting payout (and resulting tax problem) would be identical, but at least wouldn't be any larger. But that it doesn't do anything to unwind the current situation, since you'd still be stuck with that number of shares?

I'm sure this is a "duh" question. Just trying to make sure that I am not overlooking (or underestimating) the impact of turning off reinvestment.
For sure if you don't reinvest then the amount distributed will be less than it would be if you had reinvested. It is just a tiny step in the process of reducing your relative holding in this fund and can be done at no cost per se. If the distribution per share is the same next year your problem will be a repeat of this year but would be larger if you reinvest and have more shares. I really doubt the same thing would happen again.
sycamore
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Re: Target date funds ... so much for "set and forget"

Post by sycamore »

tashnewbie wrote: Mon Jan 03, 2022 12:04 pm
ThisTooShallPass123 wrote: Mon Jan 03, 2022 11:57 am
garyscan wrote: Mon Jan 03, 2022 11:50 am I made a similar (but much smaller in scope) mistake by investing in VBIAX (balanced fund) in my taxable account.
Same thing happened to me! (Hence my questions above) The tax-efficient fund wiki (https://www.bogleheads.org/wiki/Tax-eff ... _placement) does suggest these are "Efficient" asset classes and can be placed in any account. At least this is how I read it...that the "Vanguard Balanced Index Fund" is a "balanced index fund".
One of the component parts of VBIAX is a total market bond fund ...
FWIW, unlike LifeStrategy or Target Retirement funds, the VBIAX Balanced fund itself doesn't actually hold funds. Per https://investor.vanguard.com/mutual-fu ... olio/vbiax, it holds 8966 bonds and 3611 stocks.

In that sense it's like the the Tax-Managed Balanced Index Fund mentioned in the previous post:
pingo wrote: Mon Jan 03, 2022 12:46 pm Also, it is not a fund of funds, so rebalancing between stocks and bonds is managed differently than a target fund.
muffins14
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Re: Target date funds ... so much for "set and forget"

Post by muffins14 »

You’ve gotten good advice on replicating the fund more tax-efficiently through holding VTI or VUG for US and VXUS (or even better, IXUS) for stocks and NY munis for bonds.

Work toward that with tax loss harvesting and dividend payments.

Otherwise, congrats on having $6M. That’s a nice silver lining
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sc9182
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Re: Target date funds ... so much for "set and forget"

Post by sc9182 »

livesoft wrote: Mon Jan 03, 2022 10:52 am I am very interested how the OP came to find Bogleheads.org forum, decide to join, and post. What's the story there? Long-time reader or not?

Welcome.
Love these Fire-and-Forget NEW posts showcasing large-$$$ amounts -- especially from "brand new" accounts :-)
While leaving all the good-hearted folks riled up responding to OP's concern .. (me guessing, a blog post/article may be in the offing from a not-so-famous blogger :-)
Last edited by sc9182 on Mon Jan 03, 2022 1:59 pm, edited 1 time in total.
dbr
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Re: Target date funds ... so much for "set and forget"

Post by dbr »

I had a look at the Vanguard pages on TR funds and could not find even a footnote commenting on the tax efficiency of such funds or suggesting they are best held in tax protected accounts. In defense such TR funds are pretty much de rigueur in retirement plans as a simple choice for 401k employees to make. It doesn't follow that the same advice applies in taxable accounts.
tashnewbie
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Re: Target date funds ... so much for "set and forget"

Post by tashnewbie »

sycamore wrote: Mon Jan 03, 2022 1:49 pm
tashnewbie wrote: Mon Jan 03, 2022 12:04 pm
ThisTooShallPass123 wrote: Mon Jan 03, 2022 11:57 am
garyscan wrote: Mon Jan 03, 2022 11:50 am I made a similar (but much smaller in scope) mistake by investing in VBIAX (balanced fund) in my taxable account.
Same thing happened to me! (Hence my questions above) The tax-efficient fund wiki (https://www.bogleheads.org/wiki/Tax-eff ... _placement) does suggest these are "Efficient" asset classes and can be placed in any account. At least this is how I read it...that the "Vanguard Balanced Index Fund" is a "balanced index fund".
One of the component parts of VBIAX is a total market bond fund ...
FWIW, unlike LifeStrategy or Target Retirement funds, the VBIAX Balanced fund itself doesn't actually hold funds. Per https://investor.vanguard.com/mutual-fu ... olio/vbiax, it holds 8966 bonds and 3611 stocks.

In that sense it's like the the Tax-Managed Balanced Index Fund mentioned in the previous post:
pingo wrote: Mon Jan 03, 2022 12:46 pm Also, it is not a fund of funds, so rebalancing between stocks and bonds is managed differently than a target fund.
I don't know how I missed this. Thanks for adding!

So where would the tax inefficiency of something like VBIAX come from?
dbr
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Re: Target date funds ... so much for "set and forget"

Post by dbr »

tashnewbie wrote: Mon Jan 03, 2022 1:59 pm
sycamore wrote: Mon Jan 03, 2022 1:49 pm
tashnewbie wrote: Mon Jan 03, 2022 12:04 pm
ThisTooShallPass123 wrote: Mon Jan 03, 2022 11:57 am
garyscan wrote: Mon Jan 03, 2022 11:50 am I made a similar (but much smaller in scope) mistake by investing in VBIAX (balanced fund) in my taxable account.
Same thing happened to me! (Hence my questions above) The tax-efficient fund wiki (https://www.bogleheads.org/wiki/Tax-eff ... _placement) does suggest these are "Efficient" asset classes and can be placed in any account. At least this is how I read it...that the "Vanguard Balanced Index Fund" is a "balanced index fund".
One of the component parts of VBIAX is a total market bond fund ...
FWIW, unlike LifeStrategy or Target Retirement funds, the VBIAX Balanced fund itself doesn't actually hold funds. Per https://investor.vanguard.com/mutual-fu ... olio/vbiax, it holds 8966 bonds and 3611 stocks.

In that sense it's like the the Tax-Managed Balanced Index Fund mentioned in the previous post:
pingo wrote: Mon Jan 03, 2022 12:46 pm Also, it is not a fund of funds, so rebalancing between stocks and bonds is managed differently than a target fund.
I don't know how I missed this. Thanks for adding!

So where would the tax inefficiency of something like VBIAX come from?
Well, it did have some capital gains distributions this year. Possibly more important on average is bond interest. A difference in the tax managed fund is that the bonds are tax exempt bonds.
mikejuss
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Re: Target date funds ... so much for "set and forget"

Post by mikejuss »

I'm confused: what components in your target-date fund had the largest dividend distributions? The bonds? Then just don't buy them in your taxable account anymore.

You're not going to be able to avoid dividends altogether. With a portfolio as large as yours, they will need to be factored into your tax strategy every year.
Last edited by mikejuss on Mon Jan 03, 2022 2:36 pm, edited 4 times in total.
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lazynovice
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Re: Target date funds ... so much for "set and forget"

Post by lazynovice »

dbr wrote: Mon Jan 03, 2022 1:57 pm I had a look at the Vanguard pages on TR funds and could not find even a footnote commenting on the tax efficiency of such funds or suggesting they are best held in tax protected accounts. In defense such TR funds are pretty much de rigueur in retirement plans as a simple choice for 401k employees to make. It doesn't follow that the same advice applies in taxable accounts.
I think the problem will get worse in terms of the number of people this happens to. Most young investors are pushed into Target Date funds in their employer 401(k). It helps the employer meet the fiduciary duties that employees are not taking on too much or too little risk. Our plan is upwards of 70% of participants in Target Date funds.

As these investors accumulate enough money to open a brokerage account, they will likely gravitate toward the same fund.

I had a 30 something co-worker ask me for advice a few years ago when he got a lump sum. I directed him to this site because he is capable of understanding and applying the concepts here, but he ended up in a Vanguard target date fund. Having gains and paying taxes is not the end of the world but it is a a drag on portfolio performance.
ThisTooShallPass123
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Re: Target date funds ... so much for "set and forget"

Post by ThisTooShallPass123 »

mikejuss wrote: Mon Jan 03, 2022 2:19 pm I'm confused: what components in your target-date fund had the largest dividend distributions? The bonds? Then just don't buy them in your taxable account anymore.

You're not going to be able to avoid dividends altogether. With a portfolio as large as yours, they will need to be factored into your tax strategy every year.
It's not the dividends that are the issue here, it's the capital gain distribution. In 2020, Vanguard Target Retirement 2050 (VFIFX) had a $0.0184 per share long term capital gain distribution, or about 0.04%. In 2021, that same distribution was $4.8325 or 10.3%. That’s over a 250X increase year over year in long term capital gains distributions. Note, this is separate from the dividends.
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Re: Target date funds ... so much for "set and forget"

Post by mikejuss »

ThisTooShallPass123 wrote: Mon Jan 03, 2022 6:55 pm
mikejuss wrote: Mon Jan 03, 2022 2:19 pm I'm confused: what components in your target-date fund had the largest dividend distributions? The bonds? Then just don't buy them in your taxable account anymore.

You're not going to be able to avoid dividends altogether. With a portfolio as large as yours, they will need to be factored into your tax strategy every year.
It's not the dividends that are the issue here, it's the capital gain distribution. In 2020, Vanguard Target Retirement 2050 (VFIFX) had a $0.0184 per share long term capital gain distribution, or about 0.04%. In 2021, that same distribution was $4.8325 or 10.3%. That’s over a 250X increase year over year in long term capital gains distributions. Note, this is separate from the dividends.
Gotcha. But what components of the TDF are spitting out those capital-gains distributions? It's my understanding that equity index funds like VTSAX are quite tax friendly, even when held in gargantuan amounts.
50% VTSAX | 25% VTIAX | 25% VBTLX (retirement), 25% VTEAX (taxable)
ThisTooShallPass123
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Re: Target date funds ... so much for "set and forget"

Post by ThisTooShallPass123 »

I found some theories being discussed here: viewtopic.php?t=362699
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Re: Target date funds ... so much for "set and forget"

Post by mikejuss »

ThisTooShallPass123 wrote: Mon Jan 03, 2022 7:18 pm I found some theories being discussed here: viewtopic.php?t=362699
Does selling stocks to buy bonds trigger inordinate capital-gains distributions? I didn't think it worked that way. Wouldn't a person have more capital-gains distributions if he held onto his stocks instead of buying bonds?
50% VTSAX | 25% VTIAX | 25% VBTLX (retirement), 25% VTEAX (taxable)
dbr
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Re: Target date funds ... so much for "set and forget"

Post by dbr »

mikejuss wrote: Mon Jan 03, 2022 7:20 pm
ThisTooShallPass123 wrote: Mon Jan 03, 2022 7:18 pm I found some theories being discussed here: viewtopic.php?t=362699
Does selling stocks to buy bonds trigger inordinate capital-gains distributions? I didn't think it worked that way. Wouldn't a person have more capital-gains distributions if he held onto his stocks instead of buying bonds?
Several thinks confounded here. A person holding stocks and bonds doesn't have capital gains distributions. If that person sells appreciated stocks to rebalance his holding or even just to withdraw money he would realize a capital gain, and that would be taxed. Capital gains realized by an individual selling things and capital gains distributions issued by fund are two different things.
HeelaMonster
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Re: Target date funds ... so much for "set and forget"

Post by HeelaMonster »

dbr wrote: Mon Jan 03, 2022 1:44 pm
HeelaMonster wrote: Mon Jan 03, 2022 1:36 pm
garyscan wrote: Mon Jan 03, 2022 11:50 am .... So, to "unwind" the mistake, (1) I have turned off automatic dividend reinvestment...
Am I correct in thinking that this step (turn off auto reinvestment) will only help to the extent that future payouts will not be even higher, because they are based on a continually growing number of shares? In other words, if the exact same percent distribution was made next year, the resulting payout (and resulting tax problem) would be identical, but at least wouldn't be any larger. But that it doesn't do anything to unwind the current situation, since you'd still be stuck with that number of shares?

I'm sure this is a "duh" question. Just trying to make sure that I am not overlooking (or underestimating) the impact of turning off reinvestment.
For sure if you don't reinvest then the amount distributed will be less than it would be if you had reinvested. It is just a tiny step in the process of reducing your relative holding in this fund and can be done at no cost per se. If the distribution per share is the same next year your problem will be a repeat of this year but would be larger if you reinvest and have more shares. I really doubt the same thing would happen again.
Thanks, dbr. All clear. The "exact same thing happening again" scenario was just a hypothetical, to confirm my understanding.
SeekingZappa
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Re: Target date funds ... so much for "set and forget"

Post by SeekingZappa »

I suspect that the disproportionate distributions with the target date funds are the culmination of a changing glide path in combination with large stock market gains an annual distribution schedule. They had to sell off more stocks to hit the new allocation targets and it all showed up at once. Ballpark, the 2040 is about a 50/50 blend of LSG and LSMG which don't have the shifting allocations and pay out semi-annually. That's not to say that they couldn't also have larger than expected distributions when they hit a rebalancing point.
pingo
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Re: Target date funds ... so much for "set and forget"

Post by pingo »

mikejuss wrote: Mon Jan 03, 2022 7:20 pm
ThisTooShallPass123 wrote: Mon Jan 03, 2022 7:18 pm I found some theories being discussed here: viewtopic.php?t=362699
Does selling stocks to buy bonds trigger inordinate capital-gains distributions? I didn't think it worked that way. Wouldn't a person have more capital-gains distributions if he held onto his stocks instead of buying bonds?
I think that the Target funds try to be efficient by using inflows and outflows to help maintain their respective asset allocation, but sometimes the Target date fund would be forced to sell off appreciated assets in one or more of the underlying funds in order purchase assets in another/others to obtain the proper balance.

So, it's not quite like a TSM fund that can (mostly) buy and hold forever without heavy capital gains distributions. TSM capital gains would almost entirely be experienced at the instigation of the fund investor upon redemption of appreciated shares.
Baltazarre
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Re: Target date funds ... so much for "set and forget"

Post by Baltazarre »

Spoke to Vanguard today. The target date funds do a big rebalancing every five years. That resulted in many of the target date funds having a large rebalancing and led to a "five year" amount of capital gains. No communication about this in advance.
Geoman
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Re: Target date funds ... so much for "set and forget"

Post by Geoman »

jscassidy wrote: Mon Jan 03, 2022 8:57 pm Spoke to Vanguard today. The target date funds do a big rebalancing every five years. That resulted in many of the target date funds having a large rebalancing and led to a "five year" amount of capital gains. No communication about this in advance.
I encourage you to go to Morningstar and look at the historical data. At least for 10 years there is nothing close to the long-term capital gains that were disbursed in 2021. Look at the various links in the thread that discuss why it occurred. My hope is that this is a one time occurrence.
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lasater
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Re: Target date funds ... so much for "set and forget"

Post by lasater »

livesoft wrote: Mon Jan 03, 2022 10:40 am Since you know what is held inside your target date fund, then you can semi-duplicate it any time you want to. However, selling shares of your target date fund out of your taxable account could be problematic for you.
Thanks @livesoft. When you suggest selling TDF in taxable could be "problematic", do you mean from a capital gains tax perspective, or is there a separate issue I'm not seeing?
livesoft wrote: Mon Jan 03, 2022 10:40 am a. Do not reinvest distribution in your taxable.. If you reinvested the recent distribution consider selling just those shares before they go up or down in value. Instead use the distribution money to buy more tax-efficient investments.

b. In your situation, if you need bonds in your taxable account, then consider tax-exempt muni bonds, either National tax-exempt or Triple-NY-tax-exempt.
Given everything I've learned in this thread, I'm going to shift towards holding stock / bond mutual funds or ETFs directly versus through a TD fund. Obviously there are limits to how much VFORX it makes sense to sell to accelerate this shift, but the recent distribution reduced my basis considerably, so I can sell some relatively recent lots without incurring significant gains.
livesoft wrote: Mon Jan 03, 2022 10:40 am c. Move away from your high tax location and stop working. These two things will definitely reduce any future tax burdens that you might have.
Sounds appealing! :) Though, not sure I have an appetite for early retirement just yet. Wouldn't say no to a warmer location though. 8-)
livesoft wrote: Mon Jan 03, 2022 10:52 am I am very interested how the OP came to find Bogleheads.org forum, decide to join, and post. What's the story there? Long-time reader or not?

Welcome.
Thank you! The short answer is: long-term lurker, first time poster :) I discovered Bogleheads about ten years ago, when doing some 101 level research on investing. Although my portfolio allocation hasn't changed much since then, I regularly reference the wiki and forums when trying to wrap my head around my tax return (... apparently there's a natural law requiring tax returns to get more complex every year.)
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lasater
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Re: Target date funds ... so much for "set and forget"

Post by lasater »

sc9182 wrote: Mon Jan 03, 2022 1:57 pm Love these Fire-and-Forget NEW posts showcasing large-$$$ amounts -- especially from "brand new" accounts :-)
While leaving all the good-hearted folks riled up responding to OP's concern .. (me guessing, a blog post/article may be in the offing from a not-so-famous blogger :-)
Hah! That's a fair call out... given how much I've learned from reading the forums and wiki through the years I really should have created an account and participated before now. I do appreciate everyone's replies here and the ensuring discussion. Unfortunately though, it's not just fodder for a blog post :-/
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lasater
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Re: Target date funds ... so much for "set and forget"

Post by lasater »

Peripatetic Investor wrote: Mon Jan 03, 2022 11:50 am I would move cash dividends (and any stock with low BIG) to VTI, VXUS, and, for bond portion of your portfolio, munis and iBonds. I believe Vanguard has a NY-specific tax exempt fund you might want to consider. If you want exposure to taxable bonds, they should be moved into tax-deferred accounts.
Thanks. This all makes sense. I think the fund you're referencing is Vanguard New York Long-Term Tax-Exempt Fund (VNYTX).

One question, should I expect lower returns from a tax-exempt bonds like VNYTX or VWAHX, versus taxable bonds like VBFMX? (i.e., are the tax advantages already "priced in"?)

(Also, what does "BIG" stand for? I interpreted "stock with low BIG" as stock holdings that aren't carrying significant gains since purchase.)
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lasater
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Re: Target date funds ... so much for "set and forget"

Post by lasater »

dcare wrote: Mon Jan 03, 2022 12:22 pm Most of my Vanguard funds are in tax sheltered accounts and I don't worry too much about capital gains/dividends. Even so, I do watch for and monitor the Final estimated year-end distributions - Vanguard Advisors - https://advisors.vanguard.com/insights/ ... tributions
which this year was updated on Dec 9th and listed Target Retirement 2040 VFORX 12/28/21 12/29/21 12/30/21 68% $1.02 $0.14 $7.53 $7.67 15.55%.
This would give you time to act if necessary.
While I missed this notice, I don't think it would have helped me any, as selling out of VFORX in early December would have generated more capital gains for me versus receiving a year end distribution. That said, hopefully it helped others avoid "buying the dividend" so to speak.
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lasater
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Re: Target date funds ... so much for "set and forget"

Post by lasater »

muffins14 wrote: Mon Jan 03, 2022 1:53 pm You’ve gotten good advice on replicating the fund more tax-efficiently through holding VTI or VUG for US and VXUS (or even better, IXUS) for stocks and NY munis for bonds.

Work toward that with tax loss harvesting and dividend payments.
Thanks Muffins14. I am going to see what reallocations I can make in the short and long term. The reduced basis will help with selling some VFORX at relatively low gains.

Can I ask why you prefer IXUS over VXUS for international stocks?
Last edited by lasater on Wed Jan 05, 2022 10:42 am, edited 1 time in total.
mikejuss
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Re: Target date funds ... so much for "set and forget"

Post by mikejuss »

dbr wrote: Mon Jan 03, 2022 7:45 pm
mikejuss wrote: Mon Jan 03, 2022 7:20 pm
ThisTooShallPass123 wrote: Mon Jan 03, 2022 7:18 pm I found some theories being discussed here: viewtopic.php?t=362699
Does selling stocks to buy bonds trigger inordinate capital-gains distributions? I didn't think it worked that way. Wouldn't a person have more capital-gains distributions if he held onto his stocks instead of buying bonds?
Several thinks confounded here. A person holding stocks and bonds doesn't have capital gains distributions. If that person sells appreciated stocks to rebalance his holding or even just to withdraw money he would realize a capital gain, and that would be taxed. Capital gains realized by an individual selling things and capital gains distributions issued by fund are two different things.
I follow what you're saying, but now have a question: what the heck is a capital-gains distribution?
50% VTSAX | 25% VTIAX | 25% VBTLX (retirement), 25% VTEAX (taxable)
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lasater
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Re: Target date funds ... so much for "set and forget"

Post by lasater »

SeekingZappa wrote: Mon Jan 03, 2022 8:35 pm I suspect that the disproportionate distributions with the target date funds are the culmination of a changing glide path in combination with large stock market gains an annual distribution schedule. They had to sell off more stocks to hit the new allocation targets and it all showed up at once. Ballpark, the 2040 is about a 50/50 blend of LSG and LSMG which don't have the shifting allocations and pay out semi-annually. That's not to say that they couldn't also have larger than expected distributions when they hit a rebalancing point.
What are LSG and LSMG in this context? This is the composition published for VFORX as of 11/30

Vanguard Total Stock Market Index Fund Investor Shares 48.70%
Vanguard Total International Stock Index Fund Investor Shares 32.00%
Vanguard Total Bond Market II Index Fund Investor Shares** 13.20%
Vanguard Total International Bond Index Fund Investor Shares 1 6.10%
Vanguard Total International Bond II Index Fund 0.00%
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lasater
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Re: Target date funds ... so much for "set and forget"

Post by lasater »

mikejuss wrote: Wed Jan 05, 2022 10:38 am
dbr wrote: Mon Jan 03, 2022 7:45 pm
mikejuss wrote: Mon Jan 03, 2022 7:20 pm
Does selling stocks to buy bonds trigger inordinate capital-gains distributions? I didn't think it worked that way. Wouldn't a person have more capital-gains distributions if he held onto his stocks instead of buying bonds?
Several thinks confounded here. A person holding stocks and bonds doesn't have capital gains distributions. If that person sells appreciated stocks to rebalance his holding or even just to withdraw money he would realize a capital gain, and that would be taxed. Capital gains realized by an individual selling things and capital gains distributions issued by fund are two different things.
I follow what you're saying, but now have a question: what the heck is a capital-gains distribution?
@mikejuss I had the same question and reaction a couple days ago :) This page on the wiki is a good one: https://www.bogleheads.org/wiki/Capital ... stribution

My laypersons understanding is that when a fund realizes capital gains through selling appreciated assets, they are obliged to pass those gains on pro-rata to investors in the fund by end of the calendar year. These gains are then taxable to the investor, even though they didn't take any explicit action to generate them (other than choosing to hold that particular fund.)
mikejuss
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Re: Target date funds ... so much for "set and forget"

Post by mikejuss »

lasater wrote: Wed Jan 05, 2022 10:45 am
mikejuss wrote: Wed Jan 05, 2022 10:38 am
dbr wrote: Mon Jan 03, 2022 7:45 pm
mikejuss wrote: Mon Jan 03, 2022 7:20 pm
Does selling stocks to buy bonds trigger inordinate capital-gains distributions? I didn't think it worked that way. Wouldn't a person have more capital-gains distributions if he held onto his stocks instead of buying bonds?
Several thinks confounded here. A person holding stocks and bonds doesn't have capital gains distributions. If that person sells appreciated stocks to rebalance his holding or even just to withdraw money he would realize a capital gain, and that would be taxed. Capital gains realized by an individual selling things and capital gains distributions issued by fund are two different things.
I follow what you're saying, but now have a question: what the heck is a capital-gains distribution?
@mikejuss I had the same question and reaction a couple days ago :) This page on the wiki is a good one: https://www.bogleheads.org/wiki/Capital ... stribution

My laypersons understanding is that when a fund realizes capital gains through selling appreciated assets, they are obliged to pass those gains on pro-rata to investors in the fund by end of the calendar year. These gains are then taxable to the investor, even though they didn't take any explicit action to generate them (other than choosing to hold that particular fund.)
I see--thanks. I'd heard of dividend distributions but not capital-gains distributions. I will keep an eye out for them in my portfolio.

P. S.: In any event, there is no way to avoid these distributions, right, OP? So what--going back to your original post--is the problem with your target-date fund?
Last edited by mikejuss on Wed Jan 05, 2022 10:58 am, edited 1 time in total.
50% VTSAX | 25% VTIAX | 25% VBTLX (retirement), 25% VTEAX (taxable)
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