Originally posted December 12, 2022.
With bonds on pace to have their worst year on record and the broad-based stock indices that most professional investors follow down double digits YTD, one would think 2022 would be a non-event for capital gains taxes.
Unfortunately, that’s not the case for many investors who own open-end mutual funds. Many open-end mutual funds are distributing substantial capital gains this year despite racking up significant losses for investors.
Even Vanguard, arguably the most investor-friendly mutual fund shop, is saddling investors with substantial capital gains tax liabilities in funds that are down.
The problem isn’t unique to Vanguard. The problem is with open-end mutual funds as an industry. In down markets for stocks and bonds, more shareholders than usual sell their funds. As investors cash in their holdings, portfolio managers have to raise money by selling securities. Significant redemptions can force a fund manager to sell positions held at substantial gains.
Shareholders who stayed the course during the market turbulence have ended up footing the bill for all of the impatient investors who bailed on funds and caused fund managers to realize capital gains in the first place.
In 2022, for every $100,000 invested, Vanguard Equity Income is expected to generate $5,200 in capital gains, and Vanguard Wellesley, a fund down almost 8% YTD, is expected to generate $4,150 in capital gains.
We long ago stopped focusing on open-end mutual funds in our managed accounts for all but the smallest portfolios. We shifted our focus to individual securities because of problems like the capital gains tax problems, the inconvenience of once-a-day trading, the redemption fees, holding period requirements, the trading penalties, and on and on. Now we craft portfolios of individual bonds, not bond funds, and dividend-paying stocks with records of making regular annual dividend increases. We occasionally purchase open-end mutual funds or ETFs, but these are usually in market segments where pooled capital is required.
To learn more about our managed accounts and how we help investors reduce their capital gains tax liabilities through tax-loss harvesting, go to www.younginvestments.com.
You can read more about the surprise capital gains tax bills in the WSJ here.