Wednesday, December 31, 2014

Need Assistance For Making Portfolio More Tax Efficient

Over at Mutual Fund Observer we came across the following discussion: Need Assistance For Making Portfolio More Tax Efficient

Based on the capital gains distributed on several of my funds held in taxable accounts, I would like to make my taxable portfolio more tax efficient. I have a fairly high value account overall, with approx. half a million dollars in taxable accounts. They include large stakes in Vanguard Wellington, Berwyn Income, Fidelity Contrafund, Fidelity Low Priced Stock, Artisan Global Value, Scout Mid Cap, Yacktman Focused and FMI International. Some of these funds had very hefty capital gains distributions which will cause some heartburn during tax season. Do you have any suggestions on how best to substitute some of these holdings with more tax efficient ETFs or Index Funds? I'm not too concerned with slightly lower performance if the fund is more tax efficient. Thanks.

Comments

  • Take a look at Vanguard's Tax-Managed Balanced Fund (VTMFX). It is split 50/50 between U.S. stocks and municipal bonds. Good after-tax performance and low expense ratio (0.12%). I replaced VWIAX in my taxable account with VTMFX. Bear in mind, VTMFX is a bit riskier.

    Mike_E
  • Avoid high turnover funds, funds with taxable bonds. This is about all I do. I have a few stocks that pay qualifed dividends. I am in 15 % tax bracket with most of investement in IRA and Roth. I have a small annuity with no tax issues.
  • Anyone had experience with the Fidelity Spartan index funds ? Your thoughts?
  • mnzdedwards said:
    Take a look at Vanguard's Tax-Managed Balanced Fund (VTMFX). It is split 50/50 between U.S. stocks and municipal bonds. Good after-tax performance and low expense ratio (0.12%). I replaced VWIAX in my taxable account with VTMFX. Bear in mind, VTMFX is a bit riskier.

    Mike_E
    Thank you, Mike. Yes, VTMFX is on my radar for sure.
  • Keep in mind that this year is a bit unusual in terms of distributions.

    2013 was a fantastic year. If funds were still sitting on realized but undistributed losses going back to 2008, they all but surely used them up that year. (Funds are required to distribute substantially all of their net gains each year, but if they have losses, they can't distribute them. Instead, they are allowed to use them against gains in future years - I believe for up to ten years.)

    Follow that with an above average 2014 (domestically, anyway), and you've got the makings of disproportionately large distributions. It pays to keep things in perspective. For example, FMIJX (FMI Int'l) is in the 2nd percentile for 3 year after tax returns (excluding this year). And this is a very concentrated fund (29 stocks, plus some other securities) - do you want to replace it with a fund that has a gazillion holdings?

    Don't overreact to one year's taxes and lose sight of the objective - net return, not minimizing taxes. The latter is easy - don't make money.

    If you sell your shares, you'll wind up paying more taxes now (gains on the shares). If you want to make some moves, you might consider taking the distributions in cash, and investing them in newly selected funds.

    I would be more inclined to use Vanguard than Fidelity for broad based stock index funds. They tend to have lower cap gains distributions (e.g. Spartan 500 made cap gains distributions this year and in 2007), Spartan Total Market made cap gains distributions in 2007-2010). You don't see these in the Vanguard funds. (Also, the Vanguard funds have ETF shares, so they have the tax advantages of an ETF, with no bid/ask spread.)
  • Thanks for the reply, MSF. Some of the funds I've mentioned have had a record of paying out big distributions, such as FLPSX and UMBMX. Neither one of those funds have performed well over the past three years, either. FCNTX was particularly bad this year as well with a huge distribution. My point is that I would rather settle for slightly lower returns and not get hit with big distributions rather than the other way around. That's just my preference. With the size of my portfolio, I don't need to hit home runs with funds - singles or doubles will suffice. What I don't like is cutting a larger tax check than necessary every April 15.

    Your points are well taken and I will certainly take a look at some of those Vanguard ETFs and indexes.
  • +1 to msf. I would leave well enough alone, suck it up in April, and certainly not bail on Danoff and Tillinghast based on the last few years, nor even necessarily switch from Fido to Vang (though the CG points are noted). But your position is popular among some, even in the 15% bracket, and I recognize that this might sound argumentative.
  • davidrmoran said:
    +1 to msf. I would leave well enough alone, suck it up in April, and certainly not bail on Danoff and Tillinghast based on the last few years, nor even necessarily switch from Fido to Vang (though the CG points are noted). But your position is popular among some, even in the 15% bracket, and I recognize that this might sound argumentative.
    Hi David - I appreciate your comments even though I may not agree with all of them. Let's take FLPSX, for example. Tillinghast is very well respected as we all know. However, he is slowly easing away from managing this fund and will not be there forever. If you compared FLPSX with a Vanguard Mid Cap Index fund, say VIMAX, then Tillinghast's fund loses on tax adjusted returns over the 1, 3, 5 and 10 year time periods. Not bad for an index fund. FLPSX loses to VMVAX as well although the latter is a newer fund. Both index funds are more tax efficient as well. UMBMX doesn't come close to either index fund in terms of tax-adjusted returns.

    I am in the 25% tax bracket, BTW.
  • Once or twice a year, I try to find something comparable to FLPSX and fail (at least according to the metrics that matter to me, such as cost, portfolio, etc).

    The portfolio is value-leaning, non-large cap, low turnover (12%), 1/3 foreign. IMHO, it's that last factor that explains the relative underperformance the past few years. It's a global stock in all but M* classification. Which is not a bad thing if that's what you want. For that sort of fund, it's doing quite well.

    I think I finally did find a possible alternative. Polaris Global Value (PGVFX). But here's the thing - it is classified a global stock, and is somewhat more heavily foreign weighted (60/40 foreign/domestic).

    Having more foreign stocks, it doesn't match FLPSX in performance - but it does tend crudely track the same performance curve, and it helps if one wants/needs a bit more foreign exposure. (Since domestic stocks have been outperforming foreign ones, a person's portfolio could easily have tilted "too much" toward domestic.)

    It's more tax efficient (both relative to FLPSX, though this may be because it is still sitting on losses from 2008-2009 (per website). On an absolute basis), it falls into the same mid cap value box (though with slightly higher average market cap). Same low turnover (14%).

    This has been a fund on my radar for years, but I always considered it too expensive (and in the past have been disinclined to buy global funds). But it has temporarily lowered its ER (it remains to be seen whether the temporary reduction will be renewed).

    Finally, unlike FLPSX, one can benefit here from a foreign tax credit. The rule is that if a fund's portfolio is more than 50% foreign, then the fund is allowed to pass the foreign taxes through to you. FLPSX, at 1/3 foreign, can't do that. (Funds are not required to pass through the taxes, but they usually do.)

    Just an offbeat thought on a replacement or complement to FLPSX. I'd say it was thinking outside the box, but part of the appeal is that it falls within the same style box.
  • You are correct about the foreign holdings in FLPSX and that it doesn't always track exactly with a US mid cap index. In my situation, I have foreign holdings covered in other funds such as ARTGX, FMIJX and a smaller stake in GPROX, which is in a tax-deferred account. PGVFX is a pretty interesting fund with low turnover and low tax cost ratio. It did have two very bad years in 2007-2008 but has turned around nicely since then.
  • 'I'm not too concerned with slightly lower performance if the fund is more tax efficient'

    Sorry, some how that "logic" blows my mind," I'll take less money if I don't have to pay taxes", I wish employees thought that way..... I would have more money
  • Tampabay said:
    'I'm not too concerned with slightly lower performance if the fund is more tax efficient'

    Sorry, some how that "logic" blows my mind," I'll take less money if I don't have to pay taxes", I wish employees thought that way..... I would have more money
    Tampa, I'm not sure what mutual fund returns have to do with employees, but the comparison was weak tea. I hope you aren't trying to compare owning mutual funds to owning a business.

    As I said before in my posts - which you conveniently excluded - I have a large portfolio so I'm not swinging for the fences with returns. I can settle for average returns without paying more in taxes. The index funds that I cited have done very well in the past and I would have saved some money in taxes. Tax-adjusted returns do mean something, despite what you may think.

    Thanks for the constructive input, BTW.

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