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
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.
[re-posted, hopefully the moderation will be nicer to me. Sorry for the
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
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.
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.