Vanguard Funds dropped the ball lately and seriously screwed some investors. Make sure you know what happened in Vanguard ETFs and how to avoid it happening to you. I’ll start off by updating you with what happened, why investors are getting the shaft from Vanguard Funds and what it means to your portfolio, how to keep it happening to you.
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I’ve been one of the most vocal proponents of Vanguard ETFs and index funds in the past. They’re some of the best funds and lowest-cost options and I’ll continue to recommend Vanguard…but it majorly dropped the ball lately costing investors millions and it demonstrates one of the most important investing strategies you need to be using.
The problem happened in the Vanguard Target Date Retirement funds, really the 2035 fund, ticker VTTHX, and the Vanguard Target Date 2040 Fund, ticker VFORX. It started from a special deal Vanguard gives large money managers, institutional clients that regular Main Street investors don’t get. Big money institutions get a version of the fund with lower fees and some other perks. Well, at the end of 2020, Vanguard reduced the minimum investment for institutional clients to $5 million from $100 million in the target date funds. That caused billions of dollars of institutional money to sell out of the regular fund to put their money in the institutional version, in fact more than $8 billion was withdrawn from the Vanguard 2035 fund.
Now when that much money comes out of a fund, when the fund manager like Vanguard has to redeem that cash…it has to sell the stocks that were in the fund. Since those stocks had been held for years in the fund, there was a huge price difference …millions in capital gains the fund had to report and distribute to shareholders.
To understand why they do this, mutual fund earnings are taxed at a higher rate than most investors so instead, when they sell stocks and book those returns, they distribute the money to investors. You still have the same number of shares and receive the cash distribution whether you sold any shares during the year or not.
So after this sweetened deal Vanguard gave its big money clients forced it to sell stocks in the Target Date fund and book the gains it had been sitting on in those stocks for years. That triggered this distribution that went out to investors and the surprise tax bill.
Now to be fair to Vanguard, this can happen in any fund. Where Vanguard dropped the ball is by not warning investors it was going to happen and giving them a chance to do plan around it. But it can happen in any fund and it demonstrates one of the most important investing strategies you need to know, one I’ve talked about on the channel before.
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Joseph Hogue, CFA spent nearly a decade as an investment analyst for institutional firms and banks. He now helps people understand their financial lives through debt payoff strategies, investing and ways to save more money. He has appeared on Bloomberg and on sites like CNBC and Morningstar. He holds the Chartered Financial Analyst (CFA) designation and is a veteran of the Marine Corps.
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