Are Your Funds Tax Efficient? - Adviser Investments

Are Your Funds Tax Efficient?

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Are Your Funds Tax Efficient?

The ultimate goal of investing isn’t necessarily to avoid taxes; it’s to maximize wealth. Yet, tax efficiency ought to be factored into your overall financial plan, even if total gains are the ultimate pursuit.

How can you get a handle on which funds will leave you with a lighter tax load? We reviewed every Fidelity and Vanguard fund and ETF for the three-year period ending March 2021 to see how they stacked up on the tax-efficiency front.

Before we dig into the data, it’s important to understand that there are two ways to calculate a fund’s tax efficiency. The first assumes you still own shares and are paying taxes on distributions along the way. The second, which accounts for short- or long-term capital gains, is used to calculate taxes after your shares are sold. Tax efficiency will generally be lower in this case, assuming the investment has gained value over time.

Because of Adviser Investments’ long-term investment philosophy, we think it’s more useful to look at the tax efficiency of funds you plan to hold on to—so we’re looking at what’s called the tax-adjusted return “pre-liquidation.” (When our clients are taking withdrawals, however, we do consider how taxes will come into play when deciding what to sell, and together, we work out a plan that best meets each client’s needs.)

Fidelity’s 10 Most Tax-Efficient Funds
wdt_ID Fund Symbol Annualized 3-Year Return Tax-Adjusted 3-Year Return Tax Efficiency
1 Contrafund FLCNX 18.4 18.3 99.4
2 Blue Chip Growth FBCGX 29.4 29.2 99.2
3 Adv. Intl. Capital App I FCPIX 12.2 12.1 99.1
4 Adv. Intl. Growth I FIIIX 11.8 11.6 98.4
5 Intl. Capital Apprec. FAPCX 12.7 12.5 98.3
6 MSCI Cons. Disc. ETF FDIS 25.6 25.1 98.2
7 MSCI Info Tech ETF FTEC 28.3 27.7 98.1
8 Nasdaq Comp. ETF ONEQ 24.5 24.0 98.0
9 Growth Strategies FSKGX 17.5 17.1 97.9
10 Advisor Cons. Disc. I FCNIX 21.0 20.6 97.9
Fidelity’s 10 Least Tax-Efficient Funds
wdt_ID Fund Symbol Annualized 3-Year Return Tax-Adjusted 3-Year Return Tax Efficiency
2 Flex Mid Cap Growth FFMGX 24.3 16.1 66.4
3 Series Real Estate Inc. FSREX 8.0 5.3 66.4
4 Export and Multinatl. FEXPX 5.0 3.2 64.5
5 SAI Intl Value Index FIWCX 1.7 1.1 61.1
6 Intl Value Factor ETF FIVA 3.2 1.9 60.4
7 Select Insurance Port. FSPCX 9.1 5.3 58.5
8 Select Banking FSRBX 7.0 3.4 48.0
9 Advisor EMEA I FIEMX 1.9 0.8 42.7
10 Select Air Transp. Port. FSAIX 3.0 1.0 31.4
11 Japan Smaller Cos. FJSCX 1.6 0.4 23.6
Source: Morningstar. Note: Three-year returns are annualized through March 2021. After-tax returns assume the highest applicable tax rate for each distribution and reinvestment of the after-tax balance. Funds with losses over the period were excluded from the table.

You may notice that a handful of funds from each family have excellent tax efficiency, yet their after-tax returns were weaker than some of their less efficient cousins. A clear example is Fidelity International Capital Appreciation, which allowed investors to keep more than 99% of their gains after taxes on distributions, making it the firm’s third-most tax-efficient fund over the period. It generated 12.1% per year. Meanwhile, Flex Mid Cap Growth fund, one of Fidelity’s 10 least tax-efficient funds, gained over 16% per year after taxes.

Vanguard’s 10 Most Tax-Efficient Funds
wdt_ID Fund Symbol Annualized 3-Year Return Tax-Adjusted 3-Year Return Tax Efficiency
1 Small Cap Growth Idx. VISGX 19.2 19.1 99.1
2 Growth Index Investor VIGRX 23.0 22.7 98.9
3 Russ 2000 Growth ETF VTWG 17.2 17.0 98.8
4 Russ 1000 Growth ETF VONG 22.7 22.4 98.7
5 Mega Cap Growth ETF MGK 23.7 23.3 98.5
6 Info. Tech. ETF VGT 29.4 29.0 98.5
7 Mid-Cap Growth ETF VOT 19.2 18.9 98.5
8 US Momentum ETF VFMO 18.4 18.1 98.4
9 S&P 500 Growth ETF VOOG 20.5 20.0 98.0
10 Comms. Services ETF VOX 17.1 16.8 97.9
Vanguard’s 10 Least Tax-Efficient Funds
wdt_ID Fund Symbol Annualized 3-Year Return Tax-Adjusted 3-Year Return Tax Efficiency
1 Wellington Investor VWELX 11.4 9.3 81.8
2 Wellesley Income Inv VWINX 8.4 6.7 79.7
3 Global Min. Vol. VMNVX 6.4 5.0 78.9
4 Health Care Inv. VGHCX 11.7 9.2 78.4
5 Selected Value Inv. VASVX 10.1 7.7 76.7
6 Windsor Investor VWNDX 11.6 8.8 76.4
7 Target Retire 2015 Inv. VTXVX 7.4 5.6 76.1
8 Managed Alloc. Inv. VPGDX 6.8 4.9 72.0
9 Intl HiDiv Yld Idx ETF VYMI 3.8 2.6 69.2
10 Intl Explorer Inv. VINEX 3.3 2.3 68.4
Source: Morningstar. Note: Three-year returns are annualized through March 2021. After-tax returns assume the highest applicable tax rate for each distribution and reinvestment of the after-tax balance. Funds with losses over the period were excluded from the table.

Almost 84% of Vanguard’s funds (109 of 130) had a tax efficiency of 85% or better over the three years through March, compared to about 61% of the Fidelity funds (192 of 313).

Both Fidelity and Vanguard publish returns for every one of their funds on the “performance” page of their respective websites. To calculate tax efficiency, simply divide the after-tax return by the pre-tax return for a given period.

Tax efficiency is just one consideration we use when selecting funds and managers to invest with. After a long period of gains, most investors owe (or have already paid) a sizeable sum in taxes—but most are happier with more money in their pockets after taxes than holding onto tax-efficient investments that leave them with less.

Vanguard’s First Active Bond ETF

Vanguard launched its first actively managed bond ETF last week. Ultra-Short Bond ETF (VUSB) was designed in part to appeal to money market investors anxious about returns in the ultra-low interest rate environment.

Though technically a separate entity, the new bond ETF closely tracks the existing Ultra-Short-Term Bond (VUBFX) mutual fund launched in February 2015. The pair will share a management team, and expenses on the ETF are the same as Admiral shares of the mutual fund at 0.10%.

What caught our eye is that Vanguard has been relatively open about the ETF as a money market proxy. Vanguard’s head of portfolio review, Kaitlyn Caughlin, said in a press release that the ETF is for “investors seeking an option for anticipated cash needs in the range of six to 18 months.”

That’s markedly different from 2014 and 2015, following the Ultra-Short-Term Bond mutual fund’s launch, when CEO Bill McNabb was quoted as saying the fund “should not be used as a money market fund substitute.”

Since its inception through 2020, the mutual fund delivered a 10.1% return—nearly double Vanguard’s Federal Money Market fund’s return (5.6%) and close to its Short-Term Treasury (10.7%) over the same period—despite taking on only about half of the interest-rate risk. That’s a pretty good substitute for cash at a time when investors are casting a wide net due to the lack of income from money market funds.

Whether you invest in the fund or the ETF, you’ll be getting an ultra-safe, ultra-short money market alternative. And if the new ETF proves popular, we expect to see Vanguard put other active funds in an ETF wrapper, with its Core Bond fund as a likely candidate.

Is a Correction Coming?

We might see a stock market correction in 2021. But (and you knew there was a “but” coming, right?) that doesn’t mean you should do anything different with your portfolio. In fact, corrections—defined as a 10% or greater decline from a prior high—are quite common. Keep in mind that despite an almost assured pullback occurring at some point during the year, the stock market has delivered positive returns in about eight out of 10 calendar years.

In other words, market corrections are frequent but fleeting.

If we look back at the past 37 years for Vanguard’s 500 Index fund, investors experienced an average intra-year decline of 14% each year. Of course, some years the declines were much worse than 14%; others were more benign. Still, despite all those corrections, the index fund grew at a better than 11% annual rate—meaning investors doubled their money every six to seven years on average.

Source: Vanguard.

The stock market has been a compounding machine for long-term investors. The price we pay to earn those returns are the occasional corrections and bear markets. Rather than try to trade around each and every swing in the market—an impossible task—acknowledge that drawdowns happen and, with hindsight, present the best buying opportunities. 

Podcast: 5 Tax Deductions You Need to Know

With the delayed federal filing deadline of May 17, tax season has been extended an extra month—plenty of time to capitalize on recent developments from the American Rescue Plan, the CARES Act and others. In our latest podcast, members of our financial planning team offer their advice and break down everything you should know to ease this year’s tax burden, including:

  • Tax advantages for charitable contributions
  • The child tax credit and child/dependent care credit
  • How unemployment benefits are taxed
  • The nuances of home office deductions

Taxes are always a moving target as laws change—and this lively episode tells you what you need to know to take advantage of all the latest breaks available to you. Click here to listen now!

And for additional information about contribution limits, tax brackets and more, please refer to our Key Financial & Tax Planning Data reference guide (please note it does not reflect the recently announced federal income tax extension deadline of May 17, 2021).

Adviser Investments’ Today’s Market Takeaways

There’s no shortage of hyperbolic headlines and provocative punditry in the financial media. But you won’t find such hysterics here. In Today’s Market Takeaways, members of our investment team provide timely videos that clearly and concisely explain what we’re seeing in the markets.

You can find two new Market Takeaways videos on our website. Research Analyst Liz Laprade talked about potential tailwinds for investors in President Biden’s infrastructure proposal, while Vice President Steve Johnson discussed the factors behind the bull market for stocks and what he’s looking for in the weeks ahead.

We hope you find these episodes engaging and accessible, and please let us know if there are any topics you’d like to hear us address by sending an email to info@adviserinvestments.com!

About Adviser Investments

Adviser Investments operates as an independent, professional wealth management firm with expertise in Fidelity and Vanguard funds, actively managed mutual funds, ETFs, fixed-income investing, tactical strategies and financial planning. Our investment professionals focus on helping individual investors, trusts, foundations and institutions meet their investment goals. Our minimum account size is $350,000. For the eighth consecutive year, Adviser Investments was named to Barron’s list of “America’s Best Independent Advisors” and its list of the top advisory firms in Massachusetts in 2020. We have also been recognized on the Financial Times 300 Top Registered Investment Advisers list in 2014, 2015, 2016, 2018 and 2019.

For more information, please visit www.adviserinvestments.com or call 800-492-6868.


Disclaimer: This material is distributed for informational purposes only. The investment ideas and opinions contained herein should not be viewed as recommendations or personal investment advice or considered an offer to buy or sell specific securities. Our statements and opinions are subject to change at any time, without notice and should be considered only as part of a diversified portfolio. Mutual funds and exchange-traded funds mentioned herein are not necessarily held in client portfolios. Data and statistics contained in this report are obtained from what we believe to be reliable sources; however, their accuracy, completeness or reliability cannot be guaranteed.

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Past performance is not an indication of future returns. Tax, legal and insurance information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice, or as advice on whether to buy or surrender any insurance products. Personalized tax advice and tax return preparation is available through a separate, written engagement agreement with Adviser Investments Tax Solutions. We do not provide legal advice, nor sell insurance products. Always consult a licensed attorney, tax professional, or licensed insurance professional regarding your specific legal or tax situation, or insurance needs.

The Barron’s America’s Best Independent Advisers rankings consider factors such as assets under management, revenue produced for the firm, and quality of practice as determined by Barron’s editors. According to Barron’s, “around 4,000” advisory firms were considered for this recognition in 2020; with about 1,200 firms receiving recognition. The award sponsor has not disclosed how many firms were surveyed or considered for this recognition, nor the percentage of total participants that ultimately received recognition. For more information and a complete list of recipients visit https://www.barrons.com/report/top-financial-advisors/1000/2020. Years Received: 2020, 2019, 2018, 2017, 2016, 2015 & 2014.

The Barron’s Top Advisor Rankings by State (Massachusetts) (also referred to as Barron’s Top 1,200 Financial Advisers) considers factors such as assets under management, revenue produced for the firm, regulatory record, quality of practice and philanthropic work. According to Barron’s, “around 4,000” advisory firms were considered for this award in 2020, with about 1,200 firms receiving recognition. For more information and a complete list of recipients visit https://www.barrons.com/report/top-financial-advisors/1000/2020?mod=article_inline. Years Received: 2020, 2019, 2018, 2017, 2016, 2015 & 2014.

The Financial Times 300 Top Registered Investment Advisers is an independent listing produced annually by the Financial Times and Ignites Research. According to the Financial Times, in 2019, approximately 2000 firms were invited to be considered for its list; 740 responded, with 300 being named to this list. The listing reflects each practice’s performance in six primary areas: Assets under management (70-75% of a firm’s score), asset growth (15% of a firm’s score), years in existence, compliance record, credentials and online accessibility. For more information and a complete list of recipients visit https://www.ft.com/content/44d2b2b2-6cef-11e9-9ff9-8c855179f1c4Years Received: 2019, 2018, 2016, 2015 & 2014.

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