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 GainsOne 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-taxesWhat 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/?overviewVAS
https://www.vanguardinvestments.com.au/retail/ret/investments/product.html#/fundDetail/etf/portId=8205/assetCode=equity/?overviewVanguard High Growth Fund
https://www.vanguardinvestments.com.au/retail/ret/investments/product.html#/fundDetail/wholesale/portId=8134/assetCode=balanced/?overviewVDHG
https://www.vanguardinvestments.com.au/retail/ret/investments/product.html#/fundDetail/etf/portId=8221/assetCode=balanced/?overview