Tax Managed Accounts

As regards the funds, general suggestions, look at:

- the companies the fund is invested in

- the turnover

- selections made by committee?

- policies of the committee

- recent management changes

Will capital gains and dividend tax rates remain equal? Dividends are taxable quarterly.

What does this mean?

Elizabeth Richardson

Stock appreciation is taxable only when sold.

No, what does it mean that dividends are taxable quarterly. I have had dividends, I pay annually.

Elizabeth Richardson

I think he means that folks that are required to make estimated tax payments must pay quarterly. -- Doug

Thank you Doug. That is what I meant. -- George.

And actually, it's not quite 100% true: Estimated tax payments are due on the 15th of April, June, September, and January.

I'm confused on multiple levels here.

1. How does the actively managed fund "effectively track the index" and become more tax efficient at the same time? I'm assuming it must hold essentially the same funds and/or options of those funds. If so, how is holding the same funds as the index more tax efficient? It seems to me that the primary way of doing so would be to strategically buy and sell the funds as to avoid divs and cap gains (or not holding those companies at all). I don't consider that "tracking the index". Also, if they are holding the same investments as the index, how are they outperforming those same investments once cap gains and dividends have been stripped away? Please enlighten me, I'm obviously missing something.

1. What kind of index funds do you have that have higher expense ratios than actively managed funds? Low fees are the hallmark of passive index funds. I can't believe actively managed funds would be cheaper! Do the tax managed funds have a sales load?

Some symbols of what you got and what you are considering would be helpful. I'm honestly quite intrigued by the claims of these tax managed funds.

Depending on how big those losses are, it may be possible to implement some very simple tax management without using a tax-managed fund. Tax-managed funds typically try to minimize or eliminate both short- and long-term capital gains distributions. They may also avoid securities lending, which can generate ordinary income. Some have policies about receiving dividends such as delaying purchases of stock around dividend record dates, or even portfolio shifts away from dividend paying stocks to a limited extent. Depending on asset class each of these can have noticeable or "negligible" effects.

If the principal source of tax drag (costs attributable to taxes) in the investments you own is distributed capital gains, and your cost basis is well below current share prices for all or some of your holdings, a tax-managed fund isn't the only approach. Another is to liquidate loss holdings, realizing capital losses in the process. Immediately repurchase alternative investments that are highly correlated but not "substantially identical" in the eyes of the IRS. Hold those replacements for 30 days to avoid the wash-sale rule, and then sell them and repurchase your original "preferred" funds.

You can always do this, of course, but it's much more available in a

-40% stock market! The net of it, from a truly underwater portfolio, would be a capital loss carry-forward on your tax return. If large enough it could cancel out distributed capital gains for years to come, while giving you $3k in losses every year against other income. This could be a better tax outcome than buying a tax-managed fund, which introduces some new risks (eg tracking error, "implementation risk", tax code changes that result in fund policy changes and turnover).

One caveat...recently, being out of the market for even a portion of day can mean 5-10% changes in value - in your favor, or against you. Some intra-day moves have been in the 12-14% range. A new and no doubt temporary risk factor. This is unusual but it means you need to be unusually careful about timing your trades, to avoid the risk of being out of the market for long.

-Tad

All are Vanguard funds. My current index funds are Developed Market Index (VDMIX) and Small-Cap Index (NAESX) both with expense ratios of

0.22. The Tax Managed Funds are Tax Managed International (VTMGX) and Tax-Managed Small-Cap (VTMSX) with expense ratios of 0.15 and 0.13, respectively. I assume the "actively managed" aspect are the actions taken to reduce taxes. Also, the Tax Managed Funds must be held 5 years to avoid a redemption fee of 1%. I assume this fee itself reduces both expenses and taxes for the funds since there will be less forced buying and selling.

The Vanguard Small Cap fund has an Admiral Share class with an expense ratio of 0.11. There are minimums (dollars and time) required to qualify for Admiral Shares. Based on the recent market downturn, I am well below the minimum dollars required for the Admiral shares.

sn

I initially considered non Tax Managed funds with the plan to "switch back" after 30 days (as you suggested). However, I became intrigued by the Tax Managed funds now believing they may be the preferred investement (on-going lower taxes and expenses). The Tax Managed Funds have a required 5 year holding period (to avoid a redemption fee). By switching into these funds, I lose the opportunity to take further losses if the market continues to go down. The 5 year limitation is a bit of a concern. However, the funds I am considering selling have been held for +5 years and I had no inclination to sell (until now). My rebalancing is performed in my tax sheltered accounts.

I believe I have already realized adequate losses this year to cover all my gains, plus the additional $3K of income. I have some time to think through my options. I always appreciate your thoughts.

sn