Vanguard in Hot Water Over Target-Date Taxes

Vanguard in Hot Water Over Target-Date Taxes

Paleontologists once theorized that the stegosaurus may have needed two brains to function—one in its head and the other in its tail.

That idea turned out to be false. But perhaps those scientists were on to something: There’s an upside to an extra brain when you’re large and lumbering. Case in point? Vanguard. More thought may have helped the Malvern giant avoid getting caught in the crosshairs recently regarding its target-date funds.

These “set it and forget it” funds typically have a mix of equity and fixed income holdings that gradually and automatically become more conservative over time as investors approach their targeted retirement date.

As we mentioned a few weeks back, such funds are an increasingly popular option in retirement plans, and many institutional investors hold significant stakes in them. But individual investors can also invest in them via a 401(k) or other tax-deferred retirement account, or through taxable brokerage accounts.

It’s the “taxable” part that created the problem. Back in September, Vanguard announced with great fanfare its latest effort to save investors some money: A series of fee reductions, share class mergers and changes to its minimum investment amounts for its target-date funds. The firm claimed these moves would lower investor costs by an estimated $190 million.

One tiny snag: While the fee reductions and changes to the investment minimums would take effect immediately (that is, in September), the share class mergers wouldn’t be complete until February. That left a window of several months when smaller pension funds and other institutional investors could take advantage of newly lower fees by switching to institutional share classes they formerly hadn’t been eligible for.

They did so, promptly. All that money flowing out of one share class into another meant the funds’ managers had to sell some of the holdings to meet redemptions. And anyone left owning the old investor share classes realized substantial capital gains.

Those who’d invested via a taxable account were slammed with unexpected tax bills. According to a report from The Wall Street Journal, which broke the story, some investors found they owed thousands—one investor said he owed total taxes of over $150,000.

Perhaps it’s easy to lose track of the “small stuff” when you’ve got $8 trillion under management and millions of customers. With the majority of retail investors in target-date funds using tax-deferred accounts like 401(k)s (which weren’t affected by the realized capital gains) and the institutional share classes themselves due to be merged away in a few months’ time, Vanguard seems to think any negative impacts from its big move were no big deal.

Regulators don’t agree. Massachusetts Secretary of the Commonwealth William Galvin sent letters to Vanguard Group, Fidelity Investments, T. Rowe Price Group Inc., American Funds Distributors and BlackRock Investments last week, probing to find out whether individual investors were warned about the possible tax impacts of investing in target-date funds.

So far, all Vanguard’s said about the snafu is that it believes investors are “best served” by investing in target-date funds through their 401(k) accounts. In our view, that’s no way to explain an own goal. If Vanguard had simply timed the fee reductions and minimum changes to coincide with the share class mergers, the surge in outflows could have been avoided.

Webinar: What Made 2021 an Outlier for Investors? Here’s Our Team’s Take

It was a record-setting year for the stock market, but diversified investors may have felt left behind. In our quarterly webinar, our experts explained why we think 2021 was an outlier and what 2022 has in store—including what we’re doing to prepare for greater market volatility.

Watch Diversification Is Dead…and Other Modern Market Myths to learn why our investment strategists think volatility is here to stay even as the economy continues to recover. Chairman Dan Wiener, Director of Research Jeff DeMaso and Chief Investment Officer Jim Lowell discussed the current market environment and their outlook for the months ahead. Improving economic fundamentals should provide a solid foundation for further stock market gains, but inflation has become a bigger concern for investors. Rising interest rates, difficult comparisons to prior-year corporate earnings, the future of stimulus spending and higher consumer prices will all come into play in what may be a bumpier year in the markets. As always, we’re eager to share our thinking with you. Click here to watch now!

Chart of the Week: Should You Heed the January Barometer?

We monitor a wide range of data to form our outlook on the market and the broader economy—every other week, we’ll spotlight one indicator our analysts have found informative. 

By Director of Research Jeff DeMaso

With the S&P 500 on pace to notch a loss in January, prepare to see a lot of articles citing the “January Barometer.” The idea behind this old Wall Street fairy tale is: “As goes January, so goes the entire calendar year.” Ignore all of this nonsense.

Since the S&P 500 index’s 1957 launch, it has etched a January decline 26 times—not counting January 2022. In only 12 of those instances—or less than half the time—did the S&P go on to record a negative calendar-year return. And note that by including those negative January returns in my calendar-year calculations, I’m giving this measure a head start.

Historically, 14 out of 26 times, a negative January was a “false alarm”—meaning that if you sold because the market was down in January, you had better than 50/50 odds of missing out on gains.

If only market timing was that easy!

Podcast: Investing in 2022—Our Analyst Roundtable

Less than a month into 2022, the stock market has already experienced sharper dips and steeper rallies than we saw through all of last year. In this episode, Chief Investment Officer Jim Lowell sat down with a panel of Adviser Investments’ in-house analysts to discuss what they’re seeing for the year ahead, including:

• The value of diversification during tumultuous markets
• Why a down year might already be baked in for the bond market
• The near-term risks and opportunities in cryptocurrency

Despite the drawdowns, there are reasons to be optimistic about investing in 2022. Hear the insights from our expert panelists to understand why. Click to listen now!

Adviser Investments’ Today’s Market Takeaways

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.

In this week’s Market Takeaways, Vice President Steve Johnson opined on shoveling for bargains in down markets, while Senior Research Analyst Liz Laprade highlighted some important questions about Q4 GDP.

We hope you find these episodes engaging and accessible. If there are any topics you’d like us to address, please send an email to info@adviserinvestments.com!

About Adviser Investments

Adviser is a full-service wealth management firm, offering investment management, financial and tax planning, managed individual bond portfolios, and 401(k) advisory services. We’ve been helping individuals, trusts, institutions and foundations since 1994. Adviser Investments and its subsidiaries have over 5,000 clients across the country and over $8 billion in assets under management. Our portfolios encompass actively managed funds, ETFs, socially responsible investments and tactical asset allocation strategies, and we’re experts on Fidelity and Vanguard mutual funds. We take pride in being The Adviser You Can Talk To. To see a full list of our awards and recognitions, click here, and for more information, please visit www.adviserinvestments.com or call 800-492-6868.