Burned by my mutual fund

[Entropedia]

Before I stumbled on mmm I thought I was doing everything right and over several years bought an index mutual fund (WFIOX) with a fairly low expense ratio and no transaction fees. What I didn’t understand was that the fund pays a significant capital gains distribution. Last year it was about $22,000 from a $100,000 investment. So now I’m stuck paying capital gains taxes at 15%. It’s an expensive way to grow my stache.

If I’m understanding it right many index funds like VTSAX don’t pay out this capital gains distribution so I need to get out of my current fund and into something better. Since I’m tired of learning the hard way I figured I’d ask the crowd here to make sure I don’t cost myself even more money.

Because of the huge distribution most of my shares in WFIOX are now valued at less than what I payed. Some are valued higher now. Should I sell all my WFIOX and immediately buy VTSAX or let the cash sit for 30 days to avoid a wash sale?

If I sell all my shares and immediately buy VTSAX will I still have to pay taxes on the gains from the shares that are now more valuable than what I paid or will those gains be offset by the losses on the rest of the shares since they are all part of the same sale? I don’t expect to have any other capital gains for a few years in my taxable accounts.

Or another option, buy some other reasonable mutual fund that’s different enough that it would not be a wash?

Every time I think I know what I’m doing I find out I’m horribly wrong so please share your thoughts.

[Andy R]

You're paying 22k capital gains tax without a 22k capital gain?

[Entropedia]

I wasn’t following it real closely at the time but it went something like this. The original total value was about $100,000. Maybe 1700 shares at $60 per share. The next day the shares were worth maybe $48 each but I had a gains distribution in my account of $22,000. The distribution got reinvested automatically so I then had about 2200 shares at $48. I don’t know the exact numbers but that’s basically what happened.

[MustacheAndaHalf]

Wow, I just compared this fund against VOO (Vanguard S&P 500 ETF), and the "post-tax" difference is surprising:
pre-tax, 1 year performance is +4.40% vs 4.64% (proportional to expense ratio difference, but not an exact match)
post-tax, 1 year performance is -2.07% vs 3.83%, or a nearly 6% difference in 1 year performance!

http://performance.morningstar.com/fund/tax-analysis.action?t=WFIOX&region=usa&culture=en_US
"Wells Fargo Index offers well-diversified exposure to large-cap U.S. stocks, but it has high potential capital gains exposure."

I think "Wells Fargo Index Fund" is a very weird name for a fund.  It's like saying you own a "Ford Car", where "car" is the name of your car.  Most funds use something more specific, like "S&P 500" or "total stock market index fund".

If you're scared of this situation in particular, ETFs (exchange traded funds) could solve it.  When a lot of people sell within a mutual fund, the fund has to deal with selling assets to meet redemptions.  I don't know about Wells Fargo, but it's possible they didn't anticipate this situation well.  With an ETF, when anyone sells, nobody else is impacted.  It's just a sale on the stock market, two people changing ownership of shares.

Take a look at morningstar's summary / description of the next fund you buy, and look at the "tax" tab for information on the after-tax performance.  There are numerous total stock market funds that could work.  Since I like ETFs, I'll suggest a few:
VTI (Vanguard Total Stock Market ETF)
ITOT (iShares Total Stock Market ETF)
SCHB (Schwab US Broad Market ETF)

[AdrianC]

WFIOX is an S&P500 index fund. If OP switches to VTSAX/VTI would that be a wash sale?  They follow different indices, so I'm thinking not.

OP, I can commiserate. I've done the same. Live and learn, won't be making that mistake again. Vanguard ETFs only in taxable for me.

[K-ice]

Not exactly the same thing but I have my ETFs set up on a DRIP so the dividends are automatically reinvested.

For those in a taxable account, I do have a small surprise at the end of the year as I will own some tax.

I can't wait until this tax is really large (thousands) as it is proof my stash is producing & growing.

[DaveSch]

Wow, that sure is whacky. Here are few of my thoughts. I read the Morningstar report and they said the high distribution was caused because they had to sell a lot of appreciated shares to meet redemptions. Of course, people still in the fund get to pay the taxes on those gains through distributions. But you may now be able to sell at a "loss" because of  having paid tax last year.

You need to have held the shares for more than 1 year to get the long term cap gains treatment. The shares you were recently paid would be short term gains (or losses). You'll have to figure that out.
(I always take my distributions in cash, rather than additional shares as it keeps the calculations less messy.)

If you sell at a capital loss, you want to buy a fund that is "substantially different". You could buy a Mid Cap fund, hold that for a while and then sell that, or you could hold it in cash for 31 days and hope that the stock valuations don't shoot up quickly.

I was thinking of a reason why this happened in the first place. My speculation is that many people are mad at Wells Fargo for their scandals, etd. and people just yanked their dough out. So much so that they had to sell a lot to meet redemptions.

Hope that helps.
Dave

[Entropedia]

Thanks for the input everyone. I think i’ve got it figured out. I just assumed buying VTSAX/VTI would be a wash sale but after a little more reading I think not. It sounds like an etf is the way to go to avoid the same problem in the future so VTI it is.

[insufFIcientfunds]

I'm having the same problem with some Fidelity Mutual Funds. They pay a really high cap gains, which from a distance doesn't seem that bad, but when I got the 1099 and saw ~6k in cap gains, I immediately started calculating the tax liability that created.

How do I balance enjoying the cash payout of the gains without getting my butt kicked in taxes?

Not to complain, but I hate how Fidelity calculates the basis on the DRIP programs. Basically what you paid for the shares individually added up divided by the total shares owned. Would having them paid in cash and then buying them (or something else) make the basis a little cleaner? I don't mind tracking them in excel, but it seems stupid.

[K-ice]

How do I balance enjoying the cash payout of the gains without getting my butt kicked in taxes?

I am not in the US but is there a better way you can invest for asset location?

There is lots of debate about the right thing to do in Canada but Canadian dividends get preferential treatment in taxable accounts.

Holding Bonds or USD are generally best in our RRSP (tax deferred).

And holding something that you expect tho have high growth or a high capital gains is best in our Tax Free account.

Otherwise, you could turn off the DRIP, stash some cash for the taxes and then reinvest in something more tax friendly.

[powskier]

Avoid anything that says Wells Fargo.

[TexasRunner]

Avoid anything that says Wells Fargo.

+1.  And be happy your 401k is not through them...