By Dr. James M. Dahle, WCI Founder
At the end of 2021, the Vanguard Target Retirement Funds made massive Long Term Capital Gains (LTCG) distributions. This caught a lot of people by surprise. Index funds, like those that make up the Target Retirement Funds at Vanguard, don't generally distribute much in the way of LTCGs. They don't have very high turnover, and most of them have an Exchange Traded Fund (ETF) share class that allows the fund to flush capital gains out without sending them to investors. However, a combination of factors and one seemingly minor event combined to really sock it to investors who valued simplicity over tax efficiency.
Vanguard Target Retirement Funds Are Fine . . . in Tax-Protected Accounts
Target Retirement (TR) Funds are funds of funds that provide a one-stop investing solution. You pick a date near when you want to retire and put all of your money into the fund closest to that date. You forget about it, and the fund manager keeps the various asset classes in balance and, over the years, slowly decreases the aggressiveness of the mix. Easy-peasy.
However, I (and just about everyone else) have long warned that Target Retirement and other “lifecycle” funds were not the most tax-efficient way to invest. If you have both retirement accounts and taxable accounts, this may not be the best option for you. It keeps you from eking out a little extra return using savvy asset location techniques. Whether bonds in taxable or stocks in taxable are right for you, one of them is going to be in the wrong “place” when you use a fund of funds.
But if you're really into simplicity (like Mike Piper at the Oblivious Investor who uses a single Vanguard Life Strategy Fund in all of his accounts), you may be willing to trade a little tax efficiency for the hassle and behavioral benefits of a fund of funds.
However, even I never expected what happened in 2021. Neither did Piper when I asked whether this had given him pause at all about his strategy.
“Admittedly, I didn't see something like this coming,” he said. “But it's just another bullet point under what I (and plenty of other people) have been saying for years: they're not a good fit for taxable accounts.”
Note that while Mike uses a single fund of funds in all of his accounts, he does not have a taxable investing account.
The Vanguard Target Retirement Fund Disaster
As Jason Zweig explained in the Wall Street Journal:
“At the end of 2020, Vanguard reduced the minimum investment in its institutional Target Retirement funds to $5 million from $100 million. That set off an elephant stampede, as multimillion-dollar corporate retirement plans got out of the standard target funds and into the institutional equivalents. (Clients have to sell out of one format to buy the other.)
Last year, assets at Vanguard’s 2035 target fund shrank to $38 billion from $46 billion at year-end 2020; the 2040 fund shriveled to $29 billion from $36 billion. As big clients left, their sales caused the funds to offload some holdings, triggering capital gains—which could be distributed only to the dwindling group of investors who stuck around. Some had made the mistake of owning these funds in taxable accounts.”
Remember, a typical LTCG distribution for the underlying funds in Target Retirements funds such as Total Stock Market Index Fund, Total International Stock Market Index Fund, and Total Bond Market Index Fund is 0%. But for 2021, the distributions were as follows:
As you can see, most of these funds had double-digit capital gains distributions. It was 18% for TR 2040! That fund only made 14.56% in 2021. But investors owning it in taxable now have to pay taxes on 18%, and that doesn't even include dividends and short-term capital gains. The total distribution yield for 2021 was 24%. (It was as high as 27% for the 2015 fund.)
Now, this was no big deal for those who were investing in a Target Retirement fund in their Roth IRA or their 403(b) at work. But for those who were invested in the fund in a taxable account, the results were shocking and costly.
Zweig talks about a redditor called Sitting Hawk:
“[Sitting Hawk] received about $550,000 in distributions in Vanguard’s Target Retirement 2035 fund. So he owes 23.8% in federal tax and 4.95% in Illinois state tax—all told, more than $150,000 . . . He put about $1.9 million into the fund in a taxable account in 2015 after he maxed out contributions to his tax-deferred funds. He added more savings; by last year, he had about $3.6 million in taxable money in the fund.
‘I didn’t want to be that guy who’s constantly trading,' he says. ‘I just wanted to set it and forget it and have some peace of mind instead of messing around with it every couple of days. It sucks that this had to happen. HOW COULD VANGUARD LET THIS HAPPEN?'”
Now that is an extreme situation (and obviously a first-world problem, like most we discuss here on this site). But it does demonstrate just how bad this could be. Imagine getting an extra half-million in taxable income you weren't expecting and didn't need?
Lessons to Learn from Vanguard Capital Gains Distributions in 2021
There are some lessons we can take away from this. Let's go through them one by one.
#1 Funds of Funds Are for Retirement Accounts
The first one I will repeat for those in the back. If you have a taxable investing account, a fund of funds like the Vanguard Target Retirement or Life Strategy funds is not a good choice for you. I'm sorry. This is one of the problems of being wealthy. Mo' money, mo' problems, remember? You'll have to manage (or pay someone else to manage) a more complicated portfolio—or suffer the tax consequences.
Those who held a TR fund in a Roth IRA? No big deal. Vanguard just reinvested the LTCG distributions like the dividend distributions. No tax due. No downside at all.
#2 You Can Get Massive Capital Gains Distributions Without Having Any Capital Gains
Imagine if you had bought TR 2040 in your taxable account in November 2021. You didn't really have much of a return that year, but you still got walloped with the same 18% LTCG distribution. This is the case with many mutual funds. When you buy into a mutual fund, it often already has some embedded capital gains. If a large investor leaves the fund and forces the fund to sell shares of those low-basis securities, you'll be left holding the LTCG bag.
#3 Funds Without ETF Share Classes Are Vulnerable
One wonderful thing about the Vanguard index funds is that they have an Exchange Traded Fund (ETF) share class. When a large investor wants out, they simply pass them the individual securities instead of selling them and giving them cash. So, the remaining investors aren't hurt. Meanwhile, the fund is continually flushing appreciated shares out of the fund, raising the basis, and reducing future tax bills. The ETF unit creation/destruction process improves tax efficiency. In fact, the Vanguard Total Stock Market Fund has not distributed a capital gain in decades. Decades. Zero percent and certainly not 18% in a single year.
The Target Retirement Funds, like most mutual funds, do not have an ETF share class. While it does not matter so much whether you own the Vanguard fund or the Vanguard ETF in taxable for those funds that have both share classes, it certainly does for other mutual funds (Vanguard and non-Vanguard) that do not have both share classes. In those cases, use ETFs preferentially in taxable.
#4 Fund Companies, Even Vanguard, Aren't Always on Your Side
Whether anyone at Vanguard thought about this in advance is not clear, but the company certainly had competing priorities to weigh. It wanted to serve its institutional investors, and it wanted to serve its individual investors. Vanguard wanted to take care of those who invest inside retirement accounts and pensions and those who invest outside of retirement accounts. In this case, Vanguard decided it didn't care about those individual investors who were holding Target Retirement funds in their taxable accounts as much as they did the big institutional investors.
Fund companies, even Vanguard, make decisions like this all the time. Be aware. This problem is simply a consequence of how mutual funds have been taxed ever since the Investment Company Act of 1940. The funds must pass through their capital gains, whether the investors saw gains or not. It's not really fair and I don't think it is good tax policy, but this is how it works. And for some people at the end of 2021, it was awfully costly.
What do you think? Have you ever been hit with a capital gain you weren't expecting? Do you own Target Retirement funds? In taxable? What are you doing to reduce this risk in your life? Comment below!
Great article. We were hit. Curious if this will happen again in the future, and if so, what do we do with our current position? It’s too much to donate. Will sell in the next crash of course…
The bottom of the next crash may be higher than where it is today. I do not envy your dilemma of what to do about it if you’re already there. Hopefully it never happens to you again. Not sure if I’d sell and realize the rest of the capital gains or not. I’d certainly send Vanguard a message about how I feel about it.
Not Vanguard’s fault, these risk are well known and if you decide to trudge on the journey as a DIY there are costly tradeoffs. Disclaimers always there that people don’t read.
I disagree Chris. VG prides itself on hiring smart folks. They simply decided not to take action to minimize the financial impact on all invedtors (ie, merge the funds BEFORE lowering minimum invedtment) and VG force-fed the capital gains down our collective throats with no notice … no time for us to offset the gain with potential capital losses we may be manahing on sidelines. And note … VG reps have have explicitly suggested investing non-retirement funds into these Target Funds for years. This revisionist history VG touts now is irritating. I’m taking the remaining capital gains hit now and reinvedting in non-VG funds.
Signed “Disillussioned Lou”
You are so right Lou! Vanguard did this without a thought for the smaller investors with the TDF in a taxable account. I have both the 2025 and retirement income TDFs, and up until recently have not had a problem with excessive capital gains. The people who arrogantly blame those of us who had this in a taxable investment really tick me off. Had Vanguard not made the clueless move they made to encourage institutional investors to buy into the other fund, there would not have been a problem. And not for nothing, I wonder if this could happen in any fund where the investors are enticed en masse to sell; I don’t think it’s exclusive to TDFs.
If you have losses, you should grab them. No reason to carry them around.
So to get this straight, the small investors who held TR funds in taxable were forced to pay taxes because they received a lump sum distribution from the fund as it liquidated many shares when big investors left?
And did the share prices drop due to this surprise distribution ?
Yes.
Yes, but you still have the same amount of money, minus the taxes, if you reinvested it. If you’re in a tax-protected account, you were not harmed at all. Only taxable investors were.
Love your website but need some clarification on this topic – I had 500K in my IRA on Dec 28 and on Dec 30 it is only worth 420K. Granted, I didn’t have to pay out of pocket taxes, but I still lost 80K due to the share price falling. How can you say that in a tax protected account I was not harmed at all…Am I not thinking of this correctly?
Hey man, that’s why they call it “tax” protected account. IRA’s, 401k’s, 403b’s, etc only protect you from taxes you have to pay on gains. so for example if you made money from 500k to 580k, then sold the shares, you don’t pay any taxes on the $80k of profit.
on the other hand if you had done this in a taxable brokerage account, the government would want you to pay taxes on that $80k. If you held those less than a year, you would pay “short” term capital gains rates which is your ordinary income, and most docs that’s the highest tax rate at 37% federally, and then tack on whatever state you live in income tax. If you held longer than year and then the tax rates are lower at the “long” term capital gains brackets.
Why would I say you aren’t harmed? I’m not sure what you’re referring to.
This article is about a distribution made by Vanguard that harmed taxable investors. There was no damage to those investing in a tax protected account. The share value went down, but they were given a big fat distribution, which, if reinvested, restored them to the original value. In a taxable account, the investor had a big tax bill they should not have had if Vanguard had done the right thing.
Since Massachusetts settled with vanguard over this issue, anyone know of other class actions in other states and potential settlements?
Wonder what the settlement was per investor or the amount per additional
Tax dollar incurred?
Not sure of either of those questions, nor have I heard of any other states…yet.
Were the Life Strategy funds impacted as severely? Should LS funds be not invested in taxable accounts? The asset allocation in LS funds are constant; I would think the tax implications are not significant.
No, they weren’t impacted. But they could be if this ever happened to the LS funds. It isn’t that the AAs don’t change, it’s that they didn’t cause a stampede out of the fund by offering a similar but better one to the institutional investors in LS funds like they did the TR funds.
Jim,
I view target date and life cycle funds good for 3 scenarios:
1) newbie investors who haven’t developed an investment thesis yet. The newbies probably don’t have a big taxable account and their will use their 401ks and IRAs.
2) employer plans that have crappy investment options and have target dates/fund of funds. If the costs are low, these fund of funds are probably the best options.
3) the same employer plans that have “lazy” employees who don’t pick investment allocations. They can auto-invest the employees contribute in their age’s respective TD instead of cash. Or worse yet, no contribution at all.
Respectfully,
Psy-FI MD
Please check the numbers in the table regarding TR 2025. The Capital Gains distribution was actually $2.87 per share in 2021, versus the $0.44 shown (which is the number for other income).
Thanks for the correction. You’re probably right. Not sure it changes the main point though.
I got hit too. Dumb legacy TR 2030 in taxable account, bought 5 years ago when I didn’t know better. I’m selling the rest of it and just going to pay more capital gains taxes in 2022. I figure I’d rather just pay the taxes now than have these kinds of unexpected events.
Jim,
We just had a new client come to us with this same exact issue. They had about $300K in cap gains due to how Vanguard handled this situation. We will be placing those gains into Origin’s QOZ II fund.
It will be the silver lining for the client since the investment is likely to triple tax free over the next 10 years.
However, Vanguard should be held accountable for their actions because this could have been avoided with proper planning. I have always said that Vanguard is the Wal-Mart of mutual funds, and I am right. It would have been extremely unlikely this would have happened with DFA funds, since all of their funds are already institutional class funds.
Same happened to me. I am learning. This morning I moved my hospital retirement money from Vanguard 2025 to iShares S&P 500 (No total stock option). Yikes, all my other taxable retirement money and backdoor Roth is in Vanguard 2025 Target Retirement Fund! Should I move that money to VTI or VOO? I haven’t heard about Origins QO II fund. Thank you for your comment.
Another question, about hospital 457b, Dr. Dahle earlier stated not to fund but then on YouTube to fund as a basic step. Can you comment??
You didn’t need to move the retirement account money out. That wasn’t affected.
More on Origin OZ Funds here: https://origininvestments.com/offerings/qoz-fund-ii/ (Note they advertise here)
Whether you fund a non-governmental 457b or not depends on the fees, investment options, distributions options, and stability of the employer. More info here:
https://www.whitecoatinvestor.com/457-retirement-plan/
the backdoor roth/roth/401k/403b/traditional IRA that holds these funds are not affected. Only the taxable brokerage account gets hit with taxes
It’s not just Target Retirement Funds that had the mutual fund capital gain distributions blow up to gigantic proportions. Many of my other funds were “hit” with this problem and my tax bill “DOUBLED.”
I think Vanguard is in my rear view mirror and a class action lawsuit is needed here.
Would John Bogle have allowed this?
What other funds were hit?
The NAV of my Lifestrategy income and moderate growth funds were decimated at the end of 2021. The funds are typically not very volatile. I thought that this previously unseen dip was due to the poor market performance at the time, but now I’m thinking otherwise. Thoughts?
That’s probably just the regular dividend/year end distributions.
VWUAX was hit Hard
VWILX was hit hard too. This issue only limited to target funds?
I see it distributed $19 per $137 share in December. Not sure why. Do you know? Was it the same reason as the TR funds? Or just typical hypertrading by an actively managed fund?
Actively managed funds are also poor choices in a taxable account, but I’m not sure this was the same issue.
I have no clue what happened. I was hoping you or someone else can tell me if Vanguard did the samething with VWILX.
Lol blame the 1940 act, not Vanguard. You took the risks. Weren’t smart or knowledgeable enough to have the foresight and paid the consequences of having a mutual fund like a tdf in a taxable account.
You can’t be seriously playing the “you should have known the risk card” in this instance!?! Yes there is risk of some higher capital gains in TDF due to rebalancing and shifting of allocation over time, but please show me where in the prospectus or anywhere else it says there is a special risk in a TDF of Vanguard changing the limits on a completely different but related fund leading to a mass exodus by institutional investors? As another poster pointed out this could just as easily happen to VTSAX. Will you then claim everyone holding VTSAX “weren’t smart or knowledgeable enough and paid the consequences”? On top of that, TDF’s whole point is being for people who aren’t financial experts and want to hit the easy button, so what a ridiculous notion that they should know of some never-happened-before risk. Because by shear luck it didn’t happen to you, anyone who it did happen to must be an idiot. Just wow..
Couldn’t agree with you more Adam S. Well said and direct.
Those that didn’t get blindsided should be quietly thankful and don’t rub salt in the wounds of those who got screwed.
I agree that a class action lawsuit is in order. I plan to move my accounts to Fidelity. This is incredibly irresponsible of Vanguard. I no longer trust Vanguard with my investments.
One can switch from investor shares to admiral with no tax consequences. Did anyone explain why the move to institutional was not just a change in share class of the same fund?
If there was some very good reason why sales out of one class, with the realization of capital gains to buy back the same assets, Vanguard should explain. Why not just cut the expense ratio for those who now qualifies for institutional class?
As Jim points out, holding the underlying funds would have avoided the payouts.
Three fund is not that complicated.
I am a happy Vanguard cistomer but if this had happened to me, I would leave and not come back. Now has me worried that they could blow up my taxable index funds. I don’t know how but it never would have occurred to me that a change in expense ratios could result in this.
Major black eye.
They are not separate share classes in this case. They are different funds entirely. The same quirk exists with Vanguards Index 500 fund. The Institutional is a different fund. An ultra high net worth client was “converted” from an admiral share class to the Institutional 500 Index Fund by a Vanguard advisor without realizing that is was actually an exchange not a conversion. Since it was an error internally, the mistake was able to be corrected.
Question: If I’m tracking correctly, taking this “hit” now ultimately reduces future tax liability, right? Basically pay taxman now vs. later, or?
Well, there’s the time value of money to consider. Plus if you die or give it to charity before selling nobody pays those taxes.
Okay. So, by taking the now unavoidable tax hit in 2021, it would effectively make getting out of a target date fund less expensive going forward … at least from a tax perspective. Is that logic correct?
Yes, you’ve already paid a fifth of the price to get out, whether you wanted to or not. Although if the market dropped 40%, that would also lessen the blow by eliminating your gains, but be careful what you wish for.
Thank you. Been wanting to divest myself of this “bad choice” from 15+ years ago … maybe the incentive, I’ve been “waiting” for.
Cheers,
PS Just ran across your work … looking forward to getting better acquainted.
Welcome. Glad to have you here. Sorry this is what brought you.
I got hit with $150k extra in ltcg. In California the state seems to tax ltcg just like regular income. Perhaps a few years down the road I could have very well moved to another state, and avoided this extra $15k-$20k tax bill (just state). I am under the impression that vanguard has become something like cheap insurance. It’s great while monthly payments are low – but wait until you need them –
There’s no doubt they hung folks like you out to dry this year. Whether willfully or not, it still hurts to get treated like that by a company you technically own eh?
I got hit with this in the 2045 TR. It sucks because I had just invested a couple months prior. But how will this prevent tax liability later? I’m not sure I understand. Thanks
Because you paid taxes on that distribution now.
Have you heard of an attorney pursuing a class action suit? I am among the thousands that got blindsided by Vanguard
If you hear of anything I would appreciate a contact number
Terrific work you are doing on the site
Thx
Marty
I am a retired securities lawyer. I contacted a lawyer who specializes in class action lawsuits. He told me last week that no cases had been filed yet. Massachusetts securities commission is investigating. I think this is ripe for a lawsuit because Vanguard offered smaller institutions early last year to switch their money from “regular” TR funds to the mirror image institutional TR fund which had a lower expense ratio. they did this by lowering the minimum investment in the institutional TR funds from $100 million to $5million. Since most of these institutions are themselves tax exempt vehicles it cost them no taxes to transfer funds and, in fact, they had a fiduciary duty to do the transfer. The inevitable consequence of this was exactly what happened. I note that Vanguard must have realized its mistake last Fall because it is merging the institutional TR funds into the regular TR funds and lowering the expense ratio for all shareholders. You can find the document that shows this if you search for the TR funds prospectus on the Vanguard website. But taxable account shareholders are still left with the 2021 tax liability . I never thought Vanguard was that stupid to do what they did . I hope some lawyer brings a class action so we can get at least partial compensation for their stupidity which advantaged one group of TR shareholders to the detriment of others like us
Thanks — Appreciate your feedback
Class action lawsuit.
https://rosenlegal.com/submit-form/?case_id=4732
I thought the firms name is Doval. Who is this law firm?
Not yet, but it wouldn’t surprise me.
Yes, Jonas Jacobson, is a class action attorney investigating this very closely and is interested to setup a call with those affected to develop a class action case. https://www.dovel.com/our-team/jonas-jacobson/.
Sitting Hawk
Hve you spoken to him?
I am not a lawyer.
That said, I do not see how one could sur over this. I am sure Vanguard has every right to do what it did. Making a different fund available to some investors lead them to sell the one they owned and but another. Is there anything to say that.Vanguard cannot reduce minimums for some of its funds?
Even if one could find a basis for a suit, who would you sue? The fund that issued the CGs? Where is the money to pay the judgement, if there were to be one? They cannot take it out of the assets of the fund. Even if they did, it would be coming from the shareholders themselves.
I still do not understand why they did not just lower the ER without making people sell the fund.
The best you can do may be to take your business elsewhere. As I am sure many people will do.
Afan
See my comment above as to why I think you are wrong in terms of a lawsuit and that Vanguard obviously realized its mistake late last year
Can’t the same thing also happen to non-target retirement funds? Let’s say if Vanguard decides to lower its Total Stock Market Index Fund Institutional Plus Shares (VSMPX) minimum investment from $100 million to $5 million (just as what happened with the target date funds). Then might there be massive outflows and all of us in the Total Stock Market Index Mutual Funds AND in the ETF might get stuck with large capital gains? (See the following for how the ETF might be at risk of the same: https://www.morningstar.com/articles/962031/vanguards-unique-etf-structure-presents-unique-tax-risks)
All – I am an attorney that is investigating the Vanguard capital gains incident. If you would like to speak with me confidentially about your legal rights, please fee free to reach out at [email protected]. My law firm is Dovel & Luner (www.dovel.com). – Jonas Jacobson
There you go. It doesn’t take attorneys long to see an opportunity. Keep me in the loop as to what happens if you don’t mind Mr. Jacobson.
As usual the only winners will be the lawyers via fees. Any damages come out of the pocket of all investors in Vanguard (since we’re all “owners.”)
How do you value the damages to those affected, since they don’t have to pay those taxes in the future? That complexity will mean a big fee for the lawyers and a tiny amount to the affected.
I may not be the most savvy investor, but I have a Targeted Retirement fund in my Roth IRA and was hit with a giant LTCG distribution bill at the end of Dec, roughly to the same percentage scale as taxable accounts. It was listed as a debit from my account on Dec 29, 2021.
No biggie though. You just reinvest it. There are no tax consequences.
Trouble is, because of “inflation”, now might not be the best time for the retiree to be holding a high % of duration assets ( and possibly relying on income from generated from ) within portfolios such as these – as dictated by the standard “glidepath” formula.
Rather, the holding of Large cap “value” may offer a better “hedge”. Since 1941, in 5 year periods following the occurrence of the annual, year over year CPI rate printing greater than > +6.0%, large value stocks produced the “highest” annualized, inflation adjusted returns of various asset classes – this versus mid duration Treasuries, which produced the “lowest”.
https://imgur.com/a/9YJwUG6
Accompanied with the cap gains distribution surprise described, this could result in a “double whammy” of sorts for those investors holding such funds.
Is what happened here similar to what could happen to a “run” on a bank? Could it not happen to any open end mutual fund? I have not read the fund prospectus but I do not see any action by Vanguard that could be classified as illegal. They have shot themselves in the foot and caused tremendous “badwill”; but I do not see any intent to be malicious.
You don’t need “intent” to have a civil cause of action. As a retired securities lawyer, I believe that by giving an advantage to institutional investors which inevitably led to higher distributions (and thus greater tax liability) for the other investors like me , Vanguard violated the Investment Company Act of 1940 which governs mutual funds and quite ;possibly state law . Vanguard obviously realized its mistake late last year when it announced that each TR institutional fund would be merged with its “regular” counterpart in a tax free transaction. Vanguard stonewalled me when I called them last December after I saw that their estimated CG distributions for 2021 were multiples of the 2020 CG distributions for the same funds. It made no sense until Jason Zweig of the WSJ exposed their blunder. Vanguard should offer some compensation to shareholders who were adversely affected by their bonehead decision but they won’t voluntarily do anything. That is why a class action suit should be commenced
As one of the unsuspecting and trusting shareholders in a taxable Vanguard Target Retirement Lifecycle fund account , I had $ 82,000 in long term capital gains dumped on me on December 29, 2021 that resulted in $20,500 in federal and state taxes. How many vanguard shareholders were also in taxable target retirement lifecycle accounts and got hit with this tax burden due to Vanguard deciding to lower the boom on individual shareholders in taxable accounts versus the institutional shareholders in NON taxable or deferred taxable target retirement lifecycle funds?
The only way we find out is if a class action lawyer commences a lawsuit against Vanguard. As best as I can tell, no one has started such a lawsuit yet . However , the Massachusetts Securities Commission has commenced an investigation.
Thanks for your insight. I am still holding out hope Vanguard, as the respected company they are, voluntarily and proactively reimburses their shareholders in taxable target retirement funds for the unexpected tax hit. It’s simply wrong to have the shareholders absorb the financial damage because vanguard failed to anticipate the mass exodus from the target retirement lifecycle funds to the institutional fund equivalents when vanguard opened that window by lowering the investment threshold to 5 Million dollars.
I now believe that there is at least a theoretical risk of Vanguard repeating this with any of it’s index funds.
So should we convert our Index funds in Vanguard taxable accounts into respective ETFs?
The Vanguard website states that this conversion is allowed tax free.
Following is from ETF FAQs from Vanguards website.
“Conversions are allowed from both Investor and Admiral™ Shares and are tax-free if you own your mutual fund and ETF Shares through Vanguard.
Keep in mind that you can’t convert ETF Shares back to conventional shares. If you decide in the future to sell your Vanguard ETF Shares and repurchase conventional shares, that transaction could be taxable.
If you have a brokerage account at Vanguard, there’s no charge to convert conventional shares to ETF Shares. “
The index funds have ETF share classes that can be used to avoid sending capital gains to the remaining fund holders so I don’t see this as a particular risk in those funds with an ETF share class.
All should factor “The Great Reset” , as Vanguard is a huge player, along with Blackrock (world’s largest asset manager (including US Treasury) and State Street. All three behemoths are “managing the decline” of shareholder capitalism towards “stakeholder capitalism”. It is a fascistic takedown of western civilization led by Larry Fink, the City of London, and the technocrats who serve one world government…Doc.
That’s quite a conspiracy theory you’re working with there.
Thanks for acknowledging it as true.. And, please, when diagnosing any “conspiracy”, i.e., more than one “lone gunman”, wouldn’t you want theory(ies)?
https://northeastarkansasteaparty.wordpress.com/2021/09/13/evildoers-all-but-one-built-our-grill-cant-be-that-bad
From the horse’s mouth. Doc: https://blogs.mercola.com/sites/vitalvotes/archive/2022/02/16/blackrock-portfolio-manager-exposes-pfizer-fraud.aspx
Rob Berger also has an informative you tube piece on what happened to the vanguard target retirement funds when vanguard created the mass exodus from their Target retirement funds by lowering the institutional fund threshold from 110 to 5 million dollars. Seems testing the water first by lowering the threshold from 110 million to 75 or 50 million dollars for the institutional class funds would have been more sensible. There appears to be a vanguard fix in the works in 2022 to shore up the target retirement funds and prevent a repeat in the future. But no answer as to how the tax damage to individual shareholders in taxable target retirement funds hit with huge capital gains on December 29, 2021 will be made whole by vanguard.
As I noted in an earlier comment, they have fixed the problem on a going forward basis by merging each institutional TR fund with its corresponding “regular” TR fund (and lowering expense ratios for the regular TR funds). This information can be found in a Supplement to the Prospectus for the TR funds that is available on the Vanguard website.
This , of course, solves nothing for those TR fund shareholders , like me, who were stuck with much higher CG distributions in 2021(and thus tax liability) by virtue of Vanguard’s ill- conceived decision. Hopefully a class action lawyer will take up this case (or regulators like Massachusetts securities department) will force Vanguard to make whole the shareholders adversely affected.
This should not come as a surprise. Never ever hold mutual funds or managed funds in a taxable acct.
What the heck does the following statement mean? “When a large investor wants out, they simply pass them the individual securities instead of selling them and giving them cash.” Who does “they” refer to? Do these three different instances of “them” in one sentence refer to different antecedents? Please clarify.
The fund gives the large investor individual securities instead of cash.
See how ETF units are created/destroyed for additional details.
Thanks for clarifying.
Vanguard yesterday announced the closing of merger of each institutional TR fund with the corresponding “regular” TR fund and the lowering of the expense ratio for each combined fund. This is how Vanguard should have addressed this situation initially since the merger is a tax free transaction. Instead they tried to get “cute” by not offering all shareholders in the TR funds lower expenses which led to the abnormally high CG distributions to the remaining shareholders in the “regular” TR funds. This does not offer any remedy for what happened last year. Massachusetts investigation is ongoing. I have seen no evidence of the filing of any class action lawsuit about this matter.
Perhaps Vanguard’s intentional manipulation of the situation to give institutional investors the benefit of a lower expense ratio and not giving the same to its regular investors in the TD funds is evidence of the “malice” one of the previous posters referred to. Inexcusable in light of Vanguard always touting itself as the company with the lowest fees; what was the reason they did not extend that benefit to ALL investors in the TD funds? I’m hoping for a class action suit on this since I got dumped with just shy of $80,000 in LTCG.
Denise
Contact Dovel and Luner. One of their lawyers was looking to talk to investors harmed by Vanguard’s stupidity
Definition of malice: “intent to do evil”. Vanguard was plain stupid and did not think through the consequences of the impact of LTCG on taxable accounts. The unfortunate reality is that a “run on the bank” can happen to any mutual fund from any company. Vanguard was helping their institutional clients by reducing fees but completely botched the execution. Was it illegal? I think not but we’ll find out.
I have owned individual securities over the years that had huge appreciation. Some of the stocks got liquidated due to mergers and acquisitions. As a result I was subject to sizeable LTCG. It played havoc with my tax and retirement planning since I was not expecting any realized gains that would funnel me into higher tax brackets. Just had to grin and bear it.
Malice, according to Black’s Law Dictionary, can also mean “the intentional doing of a wrongful act without just cause or excuse, with an intent to inflict an injury…” The intent was to entice more companies to invest in their institutional shares, the wrongful act was that they did it without a thought of their fiduciary duty to their other investors, specifically those who hold the TDFs in a taxable account, the injury was the receipt of those capital gains (and I wonder how much of my increased dividends are tied to this fiasco) that people now have to find the money to pony up for the extra taxes, IMO. You are correct in that this scenario could happen any time the investment company creates a situation where they will have to sell off a lot of shares to pay the companies they are trying to get to move to another type of product. I’ve held these TDFs in a taxable account for a number of years and they have served me well; I knew there would be the possibility of capital gains any time they readjusted the holdings to match the target allotments they wanted. My main problem is that not only will I probably have to pay more taxes (and that’s after throwing more tax money at both the feds and the state in January once I learned of this), but that I may have to pay penalties on top of that due to this fiasco. Vanguard was very short sighted in this; they did not remember that the investor who has Vanguard funds in taxable accounts usually has them also in their IRA and Roth accounts
I totally empathize with your situation. As I described earlier, I was subject to unexpected LTCG due to mergers and acquisitions of individual securities that were sitting on significant capital gains. If I was smart enough and prescient I would have looked into the future and started liquidating my assets gradually.
Good luck on the class action suit if there is one. The legal system will have to determine: 1) did Vanguard maliciously perform a wrongful act by offering a fund with lower minimums and expense ratios? 2) did Vanguard maliciously target non-retirement share holders to make them pay additional taxes? Did Vanguard identify which shareholders would be subject to the unexpected LTCG? 3) Does Vanguard have a fiduciary duty to holders of its mutual funds? Individuals are free to buy and sell mutual funds. Restrictions and penalties are clearly spelled out in the prospectus. 4) Should Vanguard have anticipated the stampede out of the funds? Yes. But is it criminal that they did not? Brighter minds can philosophize about it.
I have looked at the prospectus but I am not an attorney.
All the best.
“At the end of 2020, Vanguard reduced the minimum investment in its institutional Target Retirement funds to $5 million from $100 million. That set off an elephant stampede, as multimillion-dollar corporate retirement plans got out of the standard target funds and into the institutional equivalents. (Clients have to sell out of one format to buy the other.)
Last year, assets at Vanguard’s 2035 target fund shrank to $38 billion from $46 billion at year-end 2020; the 2040 fund shriveled to $29 billion from $36 billion. As big clients left, their sales caused the funds to offload some holdings, triggering capital gains—which could be distributed only to the dwindling group of investors who stuck around. Some had made the mistake of owning these funds in taxable accounts.”
I’ve owned the 2040 VFORX fund as a 401K retirement fund for about 15 years. It’s done quite well historically but I’m concerned about the statement above. I watched the funds price drop dramatically after the cap gains was distributed, although because I am in a 401K it was just reinvested, instead of paid to me. So I don’t believe there are any tax obligations right now. Of course, the price is still down with the recent market trends.
Two questions:
1) with the “big clients leaving” and us “dwindling investors”, is this fund still as strong as it was (provided the market does recover from it’s current downturn)?
2) will the recent cap gains distribution ever come back to haunt me, say when I do retire and access this fund money?
As a general novice observation, this seems very mismanaged by Vanguard and came without any warning as far as I know.
1. Sure. No problem if owned in a tax-protected account.
2. No. Not in a tax-protected account. It’s fine in a 401(k) or IRA.
Hi Bill, as you are in a 401k it shouldn’t affect you at all. Vanguard is merging the Institutional and Investor Classes of the Target Date Funds this month and reducing the fees on the Investor Class Funds. They are also lowering the minimum for the yet larger investors from $250M to $100M. Expect a similar outflow from the newly merged funds this year.
Sadly, for those of us in taxable funds Vanguard got toasted with capital gains as Vanguard focuses on larger investors to the detriment of smaller ones.
Jeff
Since it is now one fund after the merger , how is this an ongoing problem ?
Hi Jonathan. It was all in the sequence. Vanguard first lowered the minimum on the Institutional Class, resulting in the great exodus of funds looking for lower fees. In order to fund this Vanguard sold a bunch of underlying assets and reported massive realized gains.
A year later they merged the funds in a “tax-free” process. Smaller taxable investors were hit hard. If they had just merged the funds up front this all could have been avoided.