I read two recent articles from Registered Rep Magazine that reminded me that regardless of how well you plan, and strategize there is no perfect investment strategy.  It doesn’t matter if your investment goal is to mitigate taxes, or if the goal is to invest in all indexes because over time they “have” to beat the actively managed fund there will be examples that will interrupt any perfect planning.  It may be a bit too serious for this type of article but as the old adage goes:

We Plan and God Laughs

Three Common Strategies to Mitigate Taxes That Don’t Always Work

The first article titled, Tax Mitigation Using ETFs and Mutual Funds, provides three common techniques that most investors look for when investing in their perfect ETF or Mutual fund as it relates to minimizing taxes:

  1. Low Turnover
  2. ETFs (as opposed to Mutual Funds)

Within each of these strategies the article provides examples that are the anomalies.

Low Turnover to Minimize Taxes

Consider Franklin Rising Dividends (FRDPX), which has a tiny annual portfolio turnover rate of 6 percent, and Janus Contrarian (JSVAX), with a turnover of 104 percent. Both funds are top performers in the large blend category. During the past 10 years ending in May, Franklin returned 6.1 percent annually, outdoing 97 percent of competitors, while Janus returned 5.9 percent, according to Morningstar. But Janus was much more tax-efficient. After taxes, Janus returned 5.5 percent, compared to 4.8 percent for Franklin.

The reason was that this anomaly occurred was because of the different goals of the funds.  Specifically, Franklin was interested in Dividend Paying stocks, providing for taxes for its owners.

Index ETFs vs. Index Mutual Fund

These can be more tax-efficient than mutual funds, but it doesn’t always work out that way. Compare Vanguard 500 Index (VFINX), an S&P 500 index mutual fund, with two similar ETFs, iShares S&P 500 (IVV) and SPDR S&P 500 (SPY). During the past decade, the Vanguard fund returned 2.54 percent annually, lagging iShares, which returned 2.60 percent, and SPDR, with a return of 2.57 percent. But the Vanguard mutual fund was the most tax-efficient. After taxes, Vanguard returned 2.18 percent, compared to 2.12 percent for iShares and 2.04 percent for SPDR.

The reasoning, according to RegisteredRep, was that Mutual Funds are able to book losses (sell losing stocks) and ETFs aren’t.  I am not sure I entirely understand this reasoning – if anyone has insight I would be appreciative.

Investing in Vanguard Index Funds vs. Vanguard Active Funds

I don’t have any Vanguard accounts so I was shocked to learn that Vanguard even had active funds, nevertheless, that some of those active funds beat the index funds.

I couldn’t believe these stats:

Of Vanguard’s 21 active equity funds with 10-year tracks records, 15 have outperformed their benchmarks. Top performers include Vanguard Global Equity (VHGEX), Vanguard Prime Cap (VPMCX), and Vanguard Windsor II(VWNFX).

  •  Consider Vanguard Capital Opportunity (VHCOX), a large growth fund. During the 10 years ending in April, the fund returned 6.2 percent annually, outpacing Vanguard Growth Index (VIGRX) by 3 percentage points. 
  • Vanguard International Growth (VWIGX) returned 6.7 percent, compared to 5.3 percent for Vanguard Developed Markets Index (VDMIX).
  • By many such measures the actively managed Vanguard Equity Income (VEIPX), a large value fund, is superior to its passive equivalent, Vanguard Value Index (VIVAX). The active fund returned 4.8 percent annually over 10 years, compared to a return of 3 percent for the index portfolio.

The article titled, “At Vangaurd, Active Beats Passive – Frequently” has additional examples.

Regardless of Your Investment Plan Anomalies Exist

The point? There is nothing that always works when it comes to investing.