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Spiders vs. Vanguard index funds

I am considering investing some surplus money into S&P500 stocks. There are two ways to do it, one via Vanguard's index funds, and another via Spiders.
I believe that they have a different tax treatment and that with index funds, I may be forced to pay capital gains taxes, even if I never sell a share of those funds. Whereas with Spiders, I only pay tax on dividends, and pay capital gains taxes only when I personally sell.
On the other hand, if I treat Spiders as a dump for surplus money (surplus, meaning beyond the cash that I keep for safety) and take money out of there by selling SPDRs as needed, I may create a big mess with capital gains accounting.
So, is it true that Spiders are more tax efficient, and how much of a difference is there, as a matter of practical impact on my bottom line.
Thanks
i
Reply to
Igor Chudov
Yes, once I bought Vanguard intnl fund and a couple days later they classified about 10% of my deposit to be a cap gain distribution, which I stupidly had set to reinvest. So my investment stayed the same amount, except I was left with hefty tax bill.
But eventually I found the distributions to be a benefit and the reinvest to be the bad thing. It can help to bleed off some of the cap gain, because I reached a point where the fund had about doubled but was crashing. I became reluctant to sell because of the monster cap gain liability that would drop into one tax year. But the worst thing was the reinvest dribs and drabs from which I had to calculate basis from a haystack of yellowing paper across many years (before Vanguard kept track of basis - and you still cannot be 100% reliant).
Same thing with mutual funds. I tend to keep a number of funds and sell each only in entirety. Then may buy something else with the leftover. Or, of course with the mutual funds you can let the distributions pool into cash. I strongly contest the platitudes about immediate reinvestment being sacred; a little gathering cash can be useful to prevent forced sales events or you can use it to invest into something else to rebalance your portfolio or tip it more towards recent invest opportunities.
I have almost quit using mutual funds in favor of exchange traded funds. Keep one around as a mop in an IRA where no tax events happen and you can do commission free deposits and withdrawals.
Dunno, and I don't sweat the details because I can't be positive the tax treatment will be better if postponed for the future. I think you are talking about spider SPY, and here is a graph showing the historic recent decoupling of some foreign etfs skyrocketing vs SPY. No worries about holding gains long there - they'll probably make 20 times the SPY gains in a few weeks, then lose half of paper profits in an eyeblink. Be happy to sell in a flash before their bubble finishes bursting, even with the worst possible tax treatments.
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Reply to
dumbstruck
[re-posted, hopefully the moderation will be nicer to me. Sorry for the delay]
Igor Chudov writes:
Do mean specifically SPDR (the ETF with symbol SPY, managed by SSgA)? Or do you mean, in general, a large-cap index ETF?
Vanguard has only just recently launched an ETF version of their S&P 500 index fund (VOO). They'd been having trouble until recently getting approval for it, but have had other large-cap ETFs for quite some time (ie. VV). There are a couple of other companies offering S&P 500 ETFs, too, as well, as just noted, a whole bunch of other large-cap indices which might be worth considering.
It's not so much "different tax treatment" but the idea is that since ETF "creation units" are handled by an "authorized participant", the participant (typically a brokerage) trades a basked of stocks with the ETF provider for a set of shares of the ETF. In particular, if folks sell off their shares of the ETF and the trade goes that a broker swaps a batch of ETF shares with the ETF for a batch of individual equities - here's the "magic" - the ETF may exchange appreciated shares out rather than realizing gains by selling and then handing out cash the way a regular open-ended fund does.
So, yes, because of the structure of ETFs, it's possible for them to be more tax-efficient than regular open-ended index funds. Whether, in the real world, that works out, we'll have to wait and see, as this sort of thing plays out over a long period of time and the advantage will mainly be apparent after (a) a lot of appreciation of the holdings in the ETF and (b) ETF redemptions.
Typically the dangers are much worse in actively managed funds than in index funds in general, though, again, the longer-term the holdings and the more the redemptions, the worse the problem would be in a regular fund.
There's no guarantee of that. It's just a possibility if the ETF is well-managed.
Another thing to note is that the Vanguard ETFs are unique in that they are simply an additional share-class attached to their existing open-ended fund portfolios. That means that Vanguard may be able to take advantage of some of the tax advantages of the ETF structure for shareholders in their open-ended funds. The key is "maybe" - again, to see how this plays out will be a long-term exercise.
That will be the case with *any* fund and almost any investment outside of a tax deferred (or similar) account.
If you're doing it in a brokerage account which makes it easy to track individual lots purchased, it may actually be easy to manage tax consequences. When you sell, you can choose to sell the highest-cost shares - if you specifically identify them in the sell order.
Note, too, that over the next couple of years brokerages will have to track your cost basis for you. That will make it easier to deal with tax consequences when you sell.
In the absense of massive redemptions after a huge run-up, at least when comparing well-run index funds to ETFs, probably very little.
To make your life a little easier, in either case, you may want to make sure that you don't have distributions automatically re-invested for you. That'll help minimize the number of really odd and small lots to track.
--
Plain Bread alone for e-mail, thanks.  The rest gets trashed.
Reply to
BreadWithSpam
The quarterly reports of the investments you're comparing have a section that reports the fund's capital loss carry-forwards, and when those carry-forwards expire. Just like loss carry-forwards on a personal income tax return, those can be used to offset gains in future years (and when there's no net capital gain, there's no capital gain distribution). The bigger the carry-forward, the more gains that could be absorbed. Keep in mind the expiration dates though, which aren't an issue on a personal income tax return.
Also reported is the current unrealized gains and losses in the holdings of the fund.
Between these two you'll get a good sense of the likelihood of capital gain distributions in the future and be able to compare the two funds you're looking at. It's partly a function of each fund's structure, as well as the timing and mechanism for cash inflows and outflows.
An ETF by nature should have lower capital gain distributions because of its ability to reduce embedded/unrealized gains during the creation/redemption process (the specifics are discussed in the prospectus of each ETF). I do wonder if that tax-accounting trick is going to be there forever. And at least some ETFs from Vanguard are share classes of the corresponding mutual fund; the mutual fund should benefit from the ETF creation/redemption process in the same way, barring changes to tax accounting for investment companies.
There's now a decent history for the two you mentioned so you could see how it's panned out so far.
-Tad
Reply to
Tad Borek

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