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Around the World => Australia Discussion => Topic started by: misterhorsey on June 03, 2019, 07:41:31 PM

Title: Managed Funds v ETFs - Tax implications
Post by: misterhorsey on June 03, 2019, 07:41:31 PM
I currently own a Vanguard Fund (Wholesale High Growth) and Vanguard ETFs (VAS + VGS).

And I'm starting to think perhaps that ETFs are the way to go from now on, particularly since Vanguard have introduced new diversified ETFs: VDHG

But I would appreciate the thoughts of other MMMers on this.  It's a longish post so thanks in advance if you make it to the end.  Perhaps its good to outline these issues for others considering between the two investment vehicles.
 
Funds and Capital Gains

One thing I've noticed, to my dismay, is the incidental tax consequences of holding the Fund over the ETFs. Basically they have a tendency to give you a large amount of capital gains at the end of each year, generated from within the Fund.  These capital gains are independent of any buying and selling of any units you may hold.

My understanding is that the Fund needs to buy and sell shares as investors buy and sell units in the Fund, but also as certain companies may fall in or out of the index. So this creates capital gains which the Fund then has to distribute to it's unit holders.

In the 2018 Financial year I received an assesable capital gain just shy of $17k on a balance of $347k.  That's about 4.8% of the value of my investment in the fund returned to me as a assesable capital gain. Meanwhile the VAS and VGS ETFs showed negligible capital gains.

As it is taxed at my marginal rate, and that rate is relatively low, it's not the end of the world. But it does bump up the overall taxable income as well and so it's hard to plan for these events.

There are other factors to consider - franking credits distributed through the Fund, an adjustment to the cost base of the units - so it's not just the capital gains that are an issue. And there are many good reasons to invest in a fund over the ETFs: convenience, no brokerage, psychological (regular drip feed v timing the market), automatic re-balancing. But I'm slightly annoyed that this unique feature of the Funds wasn't made a little more clear to me in all the literature by Vanguard describing their products.  I appreciate that Vanguard don't really spruik or promote their products that heavily, and they frequently advise you need to seek independent financial advice, so perhaps an advisor would have brought this issues up at the beginning.

I also realise that these higher levels of capital gains may be a result of a sustained bull market and may not be such an issue in more bearish times, but the effect of these capital gains acts as a significant drag on the performance of the fund.  As well as being an administrative pain.  (If anyone can point me in the direction of how to deal with adjusting the cost base of units to account for the adjustment each year, when the units in a fund are bought over many many years - it would be appreciated!!).

Of course, is it possible that I'm misinterpreting this?  Is the relative performance of a Fund and ETF exactly the same, and the value is incorporated into the unit or ETF price?  It doesn't feel like it, particularly if the gains are crystalised and real money is becomes payable for a capital gains tax liability.

Or are ETFs truly more tax effective than a Fund?  And that this issue with Funds has been accepted because of the benefits of diversification and there was no other way to managed such large funds with so many investors until they developed more refined ETFs?  And perhaps also these wholesale funds were primarily held by high net worth individuals and insulated inside weird trust structures where income was more easily smoothed out and tax issues managed?

The introduction of diversified Vanguard ETFs would seem to address this issue. This article I found certainly thinks so:

https://www.bloomberg.com/opinion/articles/2019-05-06/vanguard-fund-investors-get-control-of-paying-taxes


What am I going to do?
It seems to me that the sensible thing to do would be to shift my investments in the High Growth Fund into the High Growth ETF.  This has the potential to trigger more capital gains, so I shouldn't do it if I'm going to end up with a huge tax bill. However, I should be able to get some of it over with no impact.  I'm also not working at the moment so the marginal tax rate i'm paying is pretty low.

The Diversified ETF seems to have the benefits of diversification, automatic rebalancing, but in a much more tax effective frame work.

I do like to pay my share of tax. But I didn't anticipate that the Fund would spring a tax liability surprise at the end of each financial year, which makes it hard to plan.  And I wanted to check with the MMM hivemind just in case I'm missing something and I make another mistake!

 
References:

VGS
https://www.vanguardinvestments.com.au/retail/ret/investments/product.html#/fundDetail/etf/portId=8212/assetCode=equity/?overview

VAS
https://www.vanguardinvestments.com.au/retail/ret/investments/product.html#/fundDetail/etf/portId=8205/assetCode=equity/?overview

Vanguard High Growth Fund
https://www.vanguardinvestments.com.au/retail/ret/investments/product.html#/fundDetail/wholesale/portId=8134/assetCode=balanced/?overview


VDHG
https://www.vanguardinvestments.com.au/retail/ret/investments/product.html#/fundDetail/etf/portId=8221/assetCode=balanced/?overview
Title: Re: Managed Funds v ETFs - Tax implications
Post by: mrmoonymartian on June 05, 2019, 01:37:42 AM
I guess the moral of the story is that one good churn deserves another... mutual fund sucker to pick up the capital gains tax bill.

Don't worry, I only realised recently that capital gains are called that because they mostly end up in Canberra.
Title: Re: Managed Funds v ETFs - Tax implications
Post by: marty998 on June 05, 2019, 02:07:29 AM
No, you are not misinterpreting it, although capital gains are distributed to ETF holders as well each year. I don't recall it being that large however.

  (If anyone can point me in the direction of how to deal with adjusting the cost base of units to account for the adjustment each year, when the units in a fund are bought over many many years - it would be appreciated!!).


For the managed fund, Vanguard will keep track of your unit cost basis, and when you eventually redeem they'll provide you with an additional tax schedule for that.

Title: Re: Managed Funds v ETFs - Tax implications
Post by: misterhorsey on June 12, 2019, 04:11:34 AM
Thanks Marty for the heads up re: the Vanguard tax schedule.

Re: ETV v Managed Funds, I guess it's unclear to me whether the ETF is a more tax effective vehicle, so I'm a bit hesitant in swapping out my units in the Fund for the ETF until I know for sure.

My own limited experience suggests it is - but I haven't owned an ETF that is equivalent to the diversified fund I own. So I can't do a like for like comparison. And it seems like no-one in the forum has much experience - or possibly the topic is to niche or boring! Fair enough!

It does have a significant impact on the choice between ETF and Managed Fund - as I've discovered.

Title: Re: Managed Funds v ETFs - Tax implications
Post by: misterhorsey on June 12, 2019, 06:27:57 PM
Re: the Tax Schedule from Vanguard

(from Guide to your AMMA tax statement: https://static.vgcontent.info/crp/intl/auw/docs/resources/TaxGuide.pdf?20170809%7C142945)

Did you dispose of any units during the year?

If you disposed of units during the year, please be advised you will no longer receive a CGT statement and CGT guide. You can still calculate your current year’s capital gain or loss position resulting from the disposal of your Vanguard units by using information provided in your transactional history statement and information contained in the AMMA tax statement. You will need to combine any capital gain or loss you make from your disposal of any units during the year, with the capital gain information from your AMMA tax statement in completing Question 18 of your tax return.



Urgh
Title: Re: Managed Funds v ETFs - Tax implications
Post by: mjr on June 13, 2019, 09:02:33 PM
Why do think that ETFs are going to be tax advantaged compared to mutual funds ?  Underneath the ETFs are the same Vanguard mutual funds.  If the fund pays out a capital gain, owners of ETFs are going get the same gains via distributions.

Different funds will have different characteristics, sure.
Title: Re: Managed Funds v ETFs - Tax implications
Post by: mrmoonymartian on June 14, 2019, 01:41:06 AM
Why do think that ETFs are going to be tax advantaged compared to mutual funds ?  Underneath the ETFs are the same Vanguard mutual funds.  If the fund pays out a capital gain, owners of ETFs are going get the same gains via distributions.

Different funds will have different characteristics, sure.
Exhibit A1 Aus mutual fund: https://api.vanguard.com/rs/gre/gls/1.3.0/documents/7639/au (https://api.vanguard.com/rs/gre/gls/1.3.0/documents/7639/au)
5 years (p.a.)
Income: 4.95
Growth: 2.42

Exhibit A2 VAS ETF: https://api.vanguard.com/rs/gre/gls/1.3.0/documents/7640/au (https://api.vanguard.com/rs/gre/gls/1.3.0/documents/7640/au)
5 years (p.a.)
Income: 4.56
Growth: 2.85


Exhibit B1 Int. mutual fund: https://api.vanguard.com/rs/gre/gls/1.3.0/documents/7707/au (https://api.vanguard.com/rs/gre/gls/1.3.0/documents/7707/au)
3 years (p.a.)
Income: 5.54
Growth: 9.08

Exhibit B2 VGS ETF: https://api.vanguard.com/rs/gre/gls/1.3.0/documents/8261/au (https://api.vanguard.com/rs/gre/gls/1.3.0/documents/8261/au)
3 years (p.a.)
Income: 3.73
Growth: 10.88


Explanation of difference already supplied: https://www.bloomberg.com/opinion/articles/2019-05-06/vanguard-fund-investors-get-control-of-paying-taxes (https://www.bloomberg.com/opinion/articles/2019-05-06/vanguard-fund-investors-get-control-of-paying-taxes)
"sexy tax part"
"huge structural advantage"
Title: Re: Managed Funds v ETFs - Tax implications
Post by: misterhorsey on June 17, 2019, 10:34:23 PM
Why do think that ETFs are going to be tax advantaged compared to mutual funds ?  Underneath the ETFs are the same Vanguard mutual funds.  If the fund pays out a capital gain, owners of ETFs are going get the same gains via distributions.

In short

- the Mutual Funds actually acquire ownership of the shares to reflect the index. So as they buy/sell/churn they realise capital gains/losses.

- whereas the ETFs are structured differently so that they enter into contracts with a market maker for the rights to underlying ownership in the shares, but ownership is not transferred.  So no capital gains/losses are realised as the funds managed under the ETF grows/shrinks/churns etc.

This is my very high level summary of what is discussed in the bloomberg article in the original post, and what martian man linked to as well. 

The beneficial ownership would seem to lie with the investors, or at least the benefits of ownership - so seems like a bit tax minimisation on a technicality. But I probably feel this way as I went with a Managed Fund without being aware of this issue.
Title: Re: Managed Funds v ETFs - Tax implications
Post by: marty998 on June 18, 2019, 04:12:28 AM
Why do think that ETFs are going to be tax advantaged compared to mutual funds ?  Underneath the ETFs are the same Vanguard mutual funds.  If the fund pays out a capital gain, owners of ETFs are going get the same gains via distributions.

In short

- the Mutual Funds actually acquire ownership of the shares to reflect the index. So as they buy/sell/churn they realise capital gains/losses.

- whereas the ETFs are structured differently so that they enter into contracts with a market maker for the rights to underlying ownership in the shares, but ownership is not transferred.  So no capital gains/losses are realised as the funds managed under the ETF grows/shrinks/churns etc.

This is my very high level summary of what is discussed in the bloomberg article in the original post, and what martian man linked to as well. 

The beneficial ownership would seem to lie with the investors, or at least the benefits of ownership - so seems like a bit tax minimisation on a technicality. But I probably feel this way as I went with a Managed Fund without being aware of this issue.

Only when the churn is large enough (in one direction or another) are the units delivered from the market maker to Vanguard and vice-versa.

I understand the size of the "baskets" delivered or redeemed is about $1.5 million but will need to check. $1.5 million is basically the minimum parcel size to get an accurate portfolio comprising the 300 stocks in the VAS fund at the appropriate number of shares for each stock.

Or something like that. Hopefully that makes sense.
Title: Re: Managed Funds v ETFs - Tax implications
Post by: misterhorsey on June 25, 2022, 09:36:11 PM
Thought I'd update this thread as I've been away for quite some time, in case anyone searches for a similar issue, and as form of carthasis for myself.

I ended up selling out of the Vanguard Managed Fund (Diversified High Growth) and transferring the funds to the equivalent ETF, VDHG, using a opportunity in the Covid crash to effectively sell out around my average entry price. Unfortunately the delay in the managed fund releasing funds meant the market kicked up a tiny percentage while I was out and I didn't get back in all in one go. Ooops! 

Also, after a few years of VDHG I noticed that the capital gains generated by the ETF are quite significant....and then after some research at other forums I discover that VDHG is a collection of wholesale managed funds, rather than more tax efficient ETFs, so effectively the same as owning the Managed Fund (albeit easier to liquidate than the managed fund.) AAARGH!   

After doing a bit of research it seems that the relative tax inefficiency of VDHG is well known,  compared to owning the individual constituent funds on their own, i.e. VAS, VGS, VGE, VISM, VAF, VBND....Vanguard state that the benefits of diversification and rebalancing offered by VDHG outweigh any tax inefficiences inherent in the structure, and I think it's actually a reasonable argument, but I'm slightly saddened and amused by my own failure to optimise my own investments. 

Title: Re: Managed Funds v ETFs - Tax implications
Post by: Notch on June 25, 2022, 10:00:17 PM
Sorry to hear that misterhorsey. I knew that VDHG is just a bundle of the managed funds, but didn't see this topic until today!

I replicate the VDHG asset allocation, using the underlying indexes.  I originally used the funds, but started getting smashed with distributions so, now I buy the ETFs.  I hold the underlying funds so I can rebalance how I want, and have freedom to play with the allocation %'s.
Title: Re: Managed Funds v ETFs - Tax implications
Post by: misterhorsey on June 25, 2022, 10:16:03 PM
Thanks Notch. It's all good. I've made a lot of mistakes in my investing life, but thankfully they haven't been too grievous, and I'm better for it in the long run.

I'm actually contemplating doing another switcheroo and going the roll your own path, although in a slightly abbreviated version that is comprised of VAS + VGS + VGE only.   Do you replicate Vanguard's allocation or have you tweaked their mix?  I see there are good arguments for customising a mix (more Aus, less Aus, more international, who needs Bonds? etc etc). On the other hand, I do appreciate the psychological/behavioural pitfalls of tinkering, and that there are good reasons to structure one's investments to prevent it. I think for me this best sums up the downfalls of too much tinkering:

https://www.youtube.com/watch?v=y1IpELCTX5w

I would probably sit tight in VDGH if it wasn't for the unwelcome distributions, as I do value the diversification / rebalancing.  But as I currently don't have any active income the big capital gains in the distros can be a pain to cover. And perhaps a VAS+VGS+VGE triple combo isn't a bad option if you don't need to draw down on it (i.e, can rely on distros when you do need $) and you can rebalance at a lesiurely schedule via reinvestments when you don't need $.
Title: Re: Managed Funds v ETFs - Tax implications
Post by: Notch on June 25, 2022, 11:06:20 PM
Haha yeah I've made plenty of missteps as well - VHY, margin loans, family trust + company structure...

I have all 7 funds that make VDHG and use its % as the basis, but I adjust the 90:10 split between the stocks and bonds indexes based on how close I am to reaching my FIRE target.  Ie. if just starting out it, it would be 100% stocks, and just as I reach the FIRE goal it will be 75% stocks, 25% bonds.
Title: Re: Managed Funds v ETFs - Tax implications
Post by: misterhorsey on June 26, 2022, 12:48:19 AM
Ah VHY.  I managed to avoid that one, but seems so appealing at first doesn't it? Who doesn't want to get paid regularly!  How could that ever be a bad thing??!!!

The ability to adjust your defensive/growth ratio according to age is quite attractive. I guess you can do it outside of VDHG simply by adding more bonds, even if you held VDHG.

One thing I'm pondering is whether atypical lean-FIREs may qualify for a slightly more aggressive split between growth/defensive assets. If you have successfully designed your life to be able to live somewhat contentedly on bread, water and the occasional inhalation of air, why not tilt the stash a little more towards growth?  Your own low consumption is your defensive asset? Although
I appreciate historically long sustained bear markets can go on for a quite a while, so perhaps it's easy to speculate like this after coming off successive bull markets.

Does beg the question of course, if you are so happy on so little why expose yourself to unnecessary volatility risk?  The answer I think is 'I'm happy living lean fire, but doesn't mean I would say no to a slightly less lean fire in the future!'. Just thinking out loud here.

Title: Re: Managed Funds v ETFs - Tax implications
Post by: marty998 on June 26, 2022, 03:41:17 AM
One thing I'm pondering is whether atypical lean-FIREs may qualify for a slightly more aggressive split between growth/defensive assets.

Most of these people are in the >100%* equities bucket with a tilt towards NDQ and VEU and have been absolutely slaughtered this year.

I've seen a noticeable drop off in their contributions to various FIRE groups the last few months.

*>100% being the ones who are debt recycling into very aggressive portfolios. It isn't going well, especially with rates starting to rise.
Title: Re: Managed Funds v ETFs - Tax implications
Post by: stashgrower on June 26, 2022, 05:47:11 AM
Sorry to hear that misterhorsey. Thanks for posting your discovery. VDHG was on my list to research but I'd not gotten that far.
Title: Re: Managed Funds v ETFs - Tax implications
Post by: misterhorsey on June 26, 2022, 08:48:29 AM
One thing I'm pondering is whether atypical lean-FIREs may qualify for a slightly more aggressive split between growth/defensive assets.

Most of these people are in the >100%* equities bucket with a tilt towards NDQ and VEU and have been absolutely slaughtered this year.

I've seen a noticeable drop off in their contributions to various FIRE groups the last few months.

*>100% being the ones who are debt recycling into very aggressive portfolios. It isn't going well, especially with rates starting to rise.

Yes, Nasdaq has been clobbered. Not surprised really with all this meme stock business, as well as the frothy boilover from the crypto cauldron, pumping it all up.  Not that I put any money on that outcome.

I must be an atypical atypical lean-FIREee then as I'm doing lean fire with boring VDHG, plus additional VAS + VDG.  I managed to get my expenditure down to a theoretical withdrawal rate of  1.47% until the latest market drops, but has since gone back up to 1.6% or so.  I guess this gives me a reasonable margin of safety.  My stash isn't very big.  And I haven't been trying particularly hard to spend so little. I have just been living a very simple life at the moment, due to choice as well as few circumstances beyond my control.

My notion of aggressive is probably quite tame compared to the NDQ crowd.  But I'm starting to think living very lean probably affords you a little more risk than just straight vanilla VDHG. Maybe even just getting rid of the 10% bonds, and a slightly higher international and emerging markets skew.  I guess I'm only slowly starting to realise that conventional investment allocations are aimed at people who live somewhat conventional lives (drive cars, like to eat regularly at restaurants, buy new things etc etc).  And if you don't fit that template,  then you have a little bit more scope to take on more risk and indeed, keeping a low withdrawal rate means that you can weather higher volatility for longer.

Title: Re: Managed Funds v ETFs - Tax implications
Post by: misterhorsey on June 26, 2022, 09:03:30 AM
Sorry to hear that misterhorsey. Thanks for posting your discovery. VDHG was on my list to research but I'd not gotten that far.

Not sure how experienced you are with the investments stashgrower, but I wouldn't totally discount VDHG for certain types of investors. Even despite my whining about it!

I've managed to encourage quite a few people to invest recently, and despite it's drawbacks, I think VDHG is still the right choice for many people.  I.e. I encouraged my brother to invest a few years back, but it took me years to get him to do so.  Seeing VDHG drop (along with the market) has been stressful for many people I know and I don't think they should consider rolling their own allocation until they've experienced market volatility and have a sense of how they react. Ultimately my brother has been quite calm with being underwater on VDHG, but it's simplicity has something to do with that.

Not sure if you've seen this website, but it's pretty detailed and informative.  This is an article on VDHG and alternatives, and the way the author sets out the pros and cons is very comprehensive.

https://passiveinvestingaustralia.com/vdhg-or-roll-your-own/

I think I do accept Vanguard's argument. That is, while VDHG has a bit of a tax drag, bottom line, the benefits and growth from being in a diversified investment will far outweigh the tax impact. That's of course assuming that they don't feel comfortable with other options.

Oh yes, another article. Critical, but also fair. And it also includes modelling of potential impact of the tax issues (which they themselves say they overstate the impact)

https://www.morningstar.com.au/funds/article/vanguard-controversy-does-vdhg-lead-to-higher/216840

I do wish Vanguard had chosen a different structure as VDHG was almost endgame in so many ways.

Anyway, a very contradictory reply from me I admit!

edit: typos


Title: Re: Managed Funds v ETFs - Tax implications
Post by: stashgrower on June 27, 2022, 06:29:09 AM
Thanks misterhorsey. I learnt several new things from those articles. As you say, the PIA article is nicely done. Your contradictory reply reflects some of the pros and cons!
Title: Re: Managed Funds v ETFs - Tax implications
Post by: misterhorsey on June 27, 2022, 08:04:31 PM
Thanks misterhorsey. I learnt several new things from those articles. As you say, the PIA article is nicely done. Your contradictory reply reflects some of the pros and cons!

No worries. I managed to shift all my investments from VDHG to a selection of constituent ETFs yesterday (VAS, VGS, VGE, VISM) - greater growth emphasis, greater overseas allocation.  Was quite stressful doing it, trying to shift in and out before the market moved, but now I've done it I'm happy to be in greater control.  I had 5 windows open in my computer at the same time. Like a professional trader (lol).

Now I've done it I feel pretty relaxed.  Uncertainty can be a challenging thing to deal with, but once you've crossed over it's never as bad/tricky as you probably think. I'm no stranger to direct share investments, so committing to investments isn't scary. I think committing to a benchmark like VDHG, but then taking a different route can be stressful for fear of underperforming that benchmark over the long term (i.e. Many years down the track...."I did all that tweaking and now I'm worse off? WTF?!")

I prepared a simple spreadsheet to aid in rebalancing.  I aim to keep a regular, but fairly relaxed approach to rebalancing, with a higher tolerance for variance from target allocation. I think there are a few floating around but I'll try and share it with the forum when I have a moment in case anyone else may wish to roll their own.
Title: Re: Managed Funds v ETFs - Tax implications
Post by: stashgrower on June 28, 2022, 06:16:08 AM
Perfect now you can relax. Impressive day. I get stressed having just two windows open lolol.

I'm revisiting how to rebalance. I shall look out for your post.