Bit of a black eye for these guys.

It’s easy for a small investor to make big mistakes. It would be even easier for giant investment firms to help prevent them—but, sadly, the asset-management industry seems to have other priorities.

Just look at what happened last month to some investors in Vanguard’s Target Retirement funds. They got whacked with huge capital-gains distributions. Those payouts triggered painful tax bills they could easily have avoided if Vanguard had simply warned them not to hold these funds outside of a tax-advantaged retirement account.

Like many investment firms, Vanguard offers target-date funds: bundles of stocks, bonds and cash that automatically become more conservative as investors approach their retirement date.

These funds are tailored for investors in 401(k)s or other retirement plans where taxes are deferred. So target funds aren’t managed to minimize dividends or capital gains. Hold them in a taxable account instead of a retirement plan, and you will owe taxes on those payouts—sometimes much more than you would in other types of funds.



That shows the importance of what financial advisers call “asset location,” the choice of whether to put particular investments in a taxable or nontaxable account.

Most of the money in Vanguard’s target funds comes from corporate and individual retirement plans, where funds’ gains and income aren’t currently taxable. However, some investors do put nonretirement money into target funds, and in December they got a nasty surprise.

Vanguard’s Target Retirement 2035 and Target Retirement 2040 funds, for example, distributed approximately 15% of their total assets as capital gains—which are taxable outside of retirement accounts.

Fury erupted on Bogleheads.org, a website popular among Vanguard investors.

One investor posted there: “I think I’m screwed by Vanguard resulting in an enormous tax bill…. I feel that Vanguard guided me down this path which is frustrating.”

In the Bogleheads area on Reddit, another online forum, an investor posting as “Sitting-Hawk” said he 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. “HOW,” he asked in capital letters, “COULD VANGUARD LET THIS HAPPEN??”



“Sitting-Hawk,” who asked me not to disclose his real name, says 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,” he says.

It happened because big clients left little ones holding the bag. Vanguard’s target funds come in more than one format. Smaller clients get the standard version; big customers like corporate retirement plans get an institutional version with identical holdings at a lower fee.

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.

Vanguard didn’t have anything to say about how it infuriated the individual investors who have taxable money in these funds.

Spokeswoman Carolyn Wegemann said that because the Target Retirement approach seeks to reduce risk over time by automatically trimming stock positions, “these funds are best served in a tax-deferred account.”

Yet nowhere on the funds’ main pages at Vanguard.com does the firm tell investors that the funds aren’t ideal for taxable accounts. The summary prospectus, a document almost no one reads, intones on page 10 of 14 that “distributions may be taxable as ordinary income or capital gain.”

Vanguard is far from alone. Few leading asset managers clearly and simply state which of their funds should be held in a taxable account.

That’s a shame, says Eric Johnson, a marketing professor at Columbia Business School and author of the book “The Elements of Choice.” When an investor in a taxable account seeks to buy a fund that might not belong there, he says, a dialogue box could pop up saying something like: “This may not be the best home for your taxable dollars. Before you trade, click here to learn more.” That would link to more-suitable choices.

A related idea has worked well at Betterment, the online investment-advice company, says Dan Egan, the firm’s head of behavioral science. When clients were about to sell an investment that could trigger taxes, some saw a pop-up prompting them to view their estimated tax liability; others didn’t. Those who saw the pop-up were 15% less likely to enter the sell order.

Little interventions like that could make a big difference to small investors. Those were the people Vanguard’s late founder, John Bogle, championed for decades. In this situation, Vanguard failed them.

SORRY LINK: https://www.wsj.com/articles/v...sjhp_columnists_pos2

Jason Zweig was the author. BTW I was not burned. I never would consider those funds outside of IRA. I am thinking it is some of the Reddit crowd although I have no evidence of that.

So you have a link? Please. Interested as I got some good money in one of those.

I don't know who wrote that article or what their motivation was.
I don't consider myself to be a especially sophisticated investor but the things they are complaining about are very basic to me.
Besides that, Vanguard and Fidelity are clearly marketed as no frills companies that offer low fees but not (in most cases) lots of extra advise or planning services. In return they charge very low fees.
These people are paying big capitol gains because they had big returns. The larger number than normal that were selling because they had made big returns and are hedging their bets in case of a market downturn. They clearly didn't follow what's happening to their investments and the market in general, at all and were asleep at the switch.

That's not on Vanguard. That's on people who don't know that mutual funds outside of tax deferred or tax free accounts make taxable distributions.

This couldn't have been the first year the fund made any dividends or capital gains and I'd be surprised if this was the first and only fund that these people have invested in outside of tax-favored accounts.

This is NOT on Vanguard at all IMO. Vanguard, like Fidelity, Charles Schwab, etc provides online investment accounts/brokerage services for 'Self Directed' Investors. If you're not paying them for financial advice/services, you should NOT expect any. If you don't know what you're doing, and you get screwed somehow (tax wise, loss of principal, etc) as a result, then it's on you and you alone!

quote:

Originally posted by Rey HRH:
That's not on Vanguard. That's on people who don't know that mutual funds outside of tax deferred or tax free accounts make taxable distributions.

This couldn't have been the first year the fund made any dividends or capital gains and I'd be surprised if this was the first and only fund that these people have invested in outside of tax-favored accounts.

That's right. Each year I had their funds outside of a tax deferred account, I got a check and a 1099 for any gains that was taxable. No surprise there.
Other funds that are in a 401K or other get the distributions rolled back into more shares in that fund and remained tax deferred.
Once you get to a certain age in retirement there are required distributions from those tax deferred funds, based on your age and life expediency. Also no surprise and clearly disclosed upfront.
You want cheap, you get hamburger and the lower price. You want steak, someone to hold your hand all the way, you pay much more.
Sounds like some whiner/liberal wrote this one.

I hold quite a few shares of a Vanguard Target Retirement fund... But all are in my IRA, so this didn't affect me one bit.


Still, the weirder part of this whole situation wasn't even mentioned in that article...

As noted, the massive capital gains distributions were due to the big outflow of businesses during 2021 from the standard investor version into the institutional version of the Target Date funds, with these holders forced to sell off their investor shares before purchasing institutional shares.

However, Vanguard then announced in September 2021 that starting in 2022 these institutional versions of the Target Date funds would be merged in with the investor versions. There will no longer be separate investor and institution versions of the target date funds.

So if Vanguard had simply gone with these mergers a few months earlier, there wouldn't have been any stampede into the institutional funds and resulting sell-offs, the mergers would not have resulted in any forced selling and huge capital gains hit for investors, and this whole thing could have been avoided.

So yeah, while it's generally unwise to hold these kinds of funds in a non-tax-advantaged account, Vanguard does appear to have played a part in dropping the ball here.

quote:

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. Some had made the mistake of owning these funds in taxable accounts.

That is pretty much the answer, Capital gains on money invested outside of a qualified retirement account is taxable, pretty basic stuff. Seems that with that much money to invest they would have had some sort of advisor. Vanguard does offer that service as an option.

quote:

Originally posted by RogueJSK:
s[/b].
-snip-
So yeah, while it's generally unwise to hold these kinds of funds in a non-tax-advantaged account, Vanguard does appear to have played a part in dropping the ball here.

Totally agree.

When you purchase a new fund you receive literature (prospectus) which informs the buyer about a variety of things - including tax liability. Many people don't bother to read it.

So these people saved a fortune by not hiring a professional tax advisor...not.

Yep, it's not on Vanguard at all.

quote:

Originally posted by RogueJSK:



However, Vanguard then announced in September 2021 that starting in 2022 these institutional versions of the Target Date funds would be merged in with the investor versions. There will no longer be separate investor and institution versions of the target date funds.

So if Vanguard had simply gone with these mergers a few months earlier, there wouldn't have been any stampede into the institutional funds and resulting sell-offs, the mergers would not have resulted in any forced selling and huge capital gains hit for investors, and this whole thing could have been avoided.

So yeah, while it's generally unwise to hold these kinds of funds in a non-tax-advantaged account, Vanguard does appear to have played a part in dropping the ball here.

That merger move appears to be reactionary. The institutional fund has lower management fees than the non-institutional. Vanguard wanted to get more business so it lowered its minimum. But that move cannibalized the non-institutional fund. Apparently, the lower limit for the institutional funds didn't get enough new business and lowered the base for the non-institutional fund. To save pennies (relatively speaking), they combined the funds.

I can't imagine them raising the management fees on the institution funds so the merger results in less management fees from the accounts that were in the non-institutional fund.

Someone fucked up.

^^^^Rey HRH
"I can't imagine them raising the management fees on the institution funds so the merger results in less management fees from the accounts that were in the non-institutional fund.

Someone fucked up."

They knew or should have known, and in finance it amounts to pretty much the same thing, what would happen when they pushed the switch.

Imagine the breakfast nook conversation:
sometime in December "hey honey are investments are doing swell, I think we should keep them."

Statement date in January: "Hey honey the mutual fund co. sold us out of a shit load of our fund and it's all taxable RTFN. Go ahead and unpack for Cancun."

It's on Vanguard. It was marketed and sold as an individual's investment when it was clear to the company that it was WAY less than ideal for those individuals.

Whether or not they get sued, and I suspect they will, they are going to lose a lot of customer goodwill.

P.S. on a corporate financial statement Good will shows up as an asset, by the way.

They raped a fund to enrich one class of investor at the expense of another class.

Despite the name of the fund, it appears that managing its actual deposit was at fault. Investors failed to fully understand what they were doing.

There are a number of things people aren't well qualified to do for themselves - haircuts, dentistry, and I will now add sophisticated retirement investing.

It sounds like a no brainer on TV seeing the ads. And then you get the results - like, new P365 owners pulling the FCU out of the grip unit (owners manual states don't do it) and we get "my slide doesn't go back on!"

Now we are hearing "My investment was assesed capital gains and I'm out three times the tax liablity!" DIY's pay the price sometimes and you get a Kaboom.

A man's got to know his weaknesses and play off their strengths. There is a substantial number of people today who think they can do anything - like, cutting their own hair. At least it will grow back quickly.

Article purports Vanguard screwed them over, but the hype there is an opportunity to bash investment companies and chortel over their less knowledgeable participants getting their throat cut. It does appear Vanguard could have done a better job of informing their clients yet what other recent issue has popped up with millions not understanding or researching side affects?

Hubris. It won't happen to them.

Good comment from WSJ reader:
TAXABLE accounts.

These are the same millionaires that are too cheap to hire a CPA and try to get the best deal for TurboTax around Dec 31 from Amazon or Costco. These are the same millionaires that are too cheap to tip on rideshare apps and online grocery delivery services.

If these guys had CPAs, they would know the consequence of using a taxable account. It's the cost of doing business without a CPA. Maybe they would have chosen a passive index fund instead in the taxable and put the target dates in the tax deferred.

Roth IRA solves all these problems. The younger you are the more you'll save.

quote:

Originally posted by Flash-LB:
So these people saved a fortune by not hiring a professional tax advisor...not.

Yep, it's not on Vanguard at all.

This.

Our money is with Vanguard. When I was working, I was pretty good at making money, but not very smart at investing it. It's worth it to me to spend a few basis points on a CFP for solid guidance.

Taxable distributions are an issue for MUTUAL FUNDS.

It can be avoided by buying an ETF.

Mutual funds were better than nothing before cars had disk brakes.

I really don't feel too bad about the guy that is stashing millions a year in investments. Boo hoo.... But Vanguard was certainly not acting in their retail customers' interest. You can see that it is the big account holders that Vanguard is concerned with.

There were a whole bunch of NEW naive investors that got taken through Robinhood and reading Wall Street Bets in Reddit.

Vanguard sends out preliminary year end distributions for all affected funds around Thanksgiving. It went out around November 23rd last year.

You can also request Vanguard take out 24% FITW from dividends and/or capital gains (and some state's SITW).

Unfortunately, most people don’t think about taxes until it’s time to prepare their tax returns.

My wife and I have index funds in our taxable account and non-index funds in our IRAs.