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It seems that converting my (non-IRA and non-Roth IRA) Vanguard mutual funds to the corresponding or equivalent ETFs is a smart tax move to make.
However, then I read this in Vanguard’s information about making the conversion.
By making the conversion, I will be giving up the average cost basis of the shares I had purchased years ago, and applying the FIFO (First In First Out) cost basis.
This is what Vanguard says:
“If you are already locked into the average cost method by a sale, transfer, partial conversion or other disposition of your Vanguard mutual fund shares, we’ll have you exit the average cost method for any eligible shares of Vanguard mutual funds and apply the FIFO cost basis method prior to this conversion to the ETF share class. This means share lots acquired prior to the conversion will be listed individually with the averaged cost.”
I don’t want to make the conversion from Vanguard mutual funds to Vanguard ETFs if it will be a bad decision from a tax perspective when it comes to changing the cost basis to FIFO.
I need some help from the Humble Dollar community. What are your thoughts folks?
I converted my Vanguard mutual funds to their companion ETFs a few years ago. One significant reason was that Vanguard largely caused large capital gains distribution in its Target Date Funds at the end of 2021. It didn’t have an impact on investments held in IRA accounts, but it did create an unwelcomed surprise for those holding the funds in taxable accounts. This article from Morningstar details the problem and also mentions of similar adverse tax consequences in other mutual funds run by J.P. Morgan, Fidelity and T. Rowe Price.
This article from State Street Global Advisors explains why ETFs are more tax efficient than mutual funds.
While large index funds typically do not have large capital gains distributions, I believe that it is prudent to own the investment in the ETF form when available.
I have always used the Specific Identification tax lot method for my former mutual funds and my current ETFs. However, when I converted my Vanguard mutual funds to their ETF equivalents, they were brought over at an average cost per share. Any subsequent purchases have been recorded with the Specific Identification tax lots. While I was disappointed that the initial individual tax lot information was not transferred over during the ETF conversion in my taxable account, my tax basis was very low, having owned the funds for decades, and it was not a material consideration for me.
Bob, thank you for sharing your experience and insights and the links you provided for me to look at.
Steve:
Interesting that this article appeared today. I JUST (20-30 minutes ago) had this exact transaction placed for my daughter’s account. BOTH of her accounts are IRAs, presently, 1 Traditional Roll over and 1 Roth.
She is 47, and her timeline is a minimum of age 67.
I converted all my accounts at Vanguard Fromm Funds to ETFs in 2013. Today, my costs are determined by “Min/Max.”
If you are in it for the long haul, average coasts become irrelevant. When it goes to your beneficiaries, they get the step up in basis, so who cares?
Good point. The beneficiaries will get the step up in basis so it will not matter. Thank you