Personal Finance

Vanguard’s $106 million TDF settlement offers a key lesson about taxes

Published

2 months ago

January 23, 2025

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There’s an important lesson for investors in Vanguard Group’s recent $106 million settlement with the Securities and Exchange Commission over its target-date funds: Being mindful of your investment account type can save you from a big tax bill in certain cases.

Vanguard, the largest target-date fund manager, agreed to pay the sum for alleged “misleading statements” over the tax consequences of reducing the asset minimum for a low-cost version of its Target Retirement Funds.

Lowering the asset minimum for its lower-cost Institutional share class — to $5 million from $100 million — triggered an exodus of investors to these funds, according to the SEC. That created “historically larger capital gains distributions and tax liabilities” for many investors who remained in the more-expensive Investor share class, the agency said.

Here’s where the lesson applies: Those taxes were only borne by investors who held the TDFs in taxable brokerage accounts, not retirement accounts.

Investors who hold investments — whether a TDF or otherwise — in a tax-advantaged account like a 401(k) plan or individual retirement accounts don’t receive annual tax bills for capital gains or income distributions.

Those who hold “tax inefficient” assets — like many bond funds, actively managed funds and target-date funds — in a taxable account may get hit with a big unwelcome tax bill in any given year, experts said.

Placing such assets in retirement accounts can make a big difference when it comes to boosting net investment returns after taxes, especially for high earners, experts said.

“By having to pull money out of your coffers to pay the tax bill, it leaves less in your portfolio to compound and grow,” said Christine Benz, director of personal finance and retirement planning at Morningstar.

Vanguard neither admitted nor denied wrongdoing in its settlement agreement with the SEC.

“Vanguard is committed to supporting the more than 50 million everyday investors and retirement savers who entrust us with their savings,” a company spokesperson wrote in an e-mailed statement. “We’re pleased to have reached this settlement and look forward to continuing to serve our investors with world-class investment options.”

Vanguard held about $1.3 trillion of assets in target-date funds at the end of 2023, according to Morningstar.

What’s best in a retirement account

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The concept of strategically holding stocks, bonds and other assets in certain account types to boost after-tax returns is known as “asset location.”

It’s a “key consideration” for high earners, Benz said.

Such investors are more likely to reach annual contribution limits for tax-sheltered retirement accounts, and therefore need to also save in taxable accounts, she said. They’re more likely to be in a higher tax bracket, too.

While most middle-class savers predominantly invest in retirement accounts, in which tax efficiency is a “non-issue,” there are certain non-retirement goals — perhaps saving for a down payment on a house a few years down the road — for which taxable accounts make more sense, Benz said.

Using an asset location strategy can raise annual after-tax returns by 0.14 to 0.41 percentage points for conservative investors (who invest more in bonds) in the mid to high income tax brackets, according to recent research by Charles Schwab.

“A retired couple with a $2 million portfolio [$1 million in a taxable account and $1 million in a tax advantaged account] could potentially see a reduction in tax drag that equates to an additional $2,800 to $8,200 per year depending on their tax bracket,” Hayden Adams, a certified public accountant, certified financial planner, and director of tax and wealth management at the Schwab Center for Financial Research, wrote of the findings.

Tax inefficient assets — which are better suited to retirement accounts — are ones that “generate regular taxable events,” Adams wrote.

Here are some examples, according to experts:

Bonds and bond funds. Bond income is generally taxed at ordinary income tax rates, instead of preferential capital-gains rates. (There are exceptions, like municipal bonds.)

Actively managed investment funds. These generally have higher turnover due to frequent buying and selling of securities within the fund. They therefore tend to generate more taxable distributions than index funds, and those distributions are shared among all fund shareholders.

Real estate investment trusts. REITs must distribute at least 90% of their income to shareholders, Adams wrote.

Short-term holdings. The profit on investments held for a year or less are taxed at short-term capital gains rates, for which the preferential tax rates for “long term” capital gains don’t apply.

Target-date funds. These and other funds that aim for a target asset allocation are a “bad bet” for taxable accounts, Benz said. They often hold tax inefficient assets like bonds and may need to sell appreciated securities to maintain their target allocation, she said.

About 90% of the potential additional after-tax return from asset location comes from two moves: switching to municipal bonds (instead of taxable bonds) in taxable accounts, and switching to index stock funds in taxable accounts and active stock funds in tax-advantaged accounts, Adams wrote.

Investors with municipal bonds or municipal money market funds avoid federal income tax on their distributions.

Exchange-traded funds also distribute capital gains to investors much less often than mutual funds, and may therefore make sense in taxable accounts, experts said.

Personal Finance

Student loan repayment tips amid challenging times for borrowers

Published

1 day ago

April 6, 2025

Business Finance News

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It’s a challenging time for many federal student loan borrowers just trying to find ways to pay off their debt.

Millions of borrowers who enrolled in the Biden administration-era Saving on a Valuable Education plan are now in limbo after the program was blocked by Republican-led legal challenges.

Meanwhile, the Trump administration has changed the terms on several other repayment plans.

To successfully keep up with your student loan payments and eventually emerge debt-free, borrowers should explore their options and understand the terms of their repayment plan. Here’s what you need to know amid major challenges to the lending system.

How the SAVE plan got blocked

A U.S. appeals court in February blocked the Biden administration’s student loan relief plan known as SAVE.

The 8th U.S. Circuit Court of Appeals sided with the seven Republican-led states that filed a lawsuit against the U.S. Department of Education’s plan. The states had argued that former President Joe Biden, with SAVE, was essentially trying to find a roundabout way to forgive student debt after the Supreme Court struck down his sweeping debt cancellation plan in June 2023.

SAVE came with two key provisions that the lawsuits targeted: It had lower monthly payments than any other federal student loan repayment plan, and it led to quicker debt erasure for those with small balances.

Forbearance has no clear end date

When its SAVE plan got tied up in legal challenges, the Biden administration put millions of borrowers who’d enrolled in the plan in an interest-free forbearance. Borrowers, if they wish, can still remain in that payment pause.

There’s no specific end date to that forbearance as of now, said Scott Buchanan, executive director of the Student Loan Servicing Alliance, a trade group for federal student loan servicers.

But unlike the Covid-era pause on student loan bills, this forbearance does not give borrowers credit toward debt forgiveness under an income-driven repayment plan or Public Service Loan Forgiveness.

Historically, at least, IDR plans limit borrowers’ monthly payments to a share of their discretionary income and cancel any remaining debt after a certain period, typically 20 years or 25 years. PSLF, which President George W. Bush signed into law in 2007, allows certain not-for-profit and government employees to have their federal student loans wiped away after 10 years of payments.

Borrowers have other options

Some borrowers who are in the SAVE program’s forbearance might want to sit tight, said higher education expert Mark Kantrowitz. Not having to make payments might be a relief to those who are experiencing any financial struggles.

Another benefit of remaining in the payment pause is that interest isn’t accumulating on your debt, like it would under other IDR plans, Buchanan explained.

“But months in SAVE forbearance do not count toward loan forgiveness, so both those considerations need to be weighed when thinking about switching plans,” Buchanan said.

If you do decide to switch out of the now-blocked SAVE plan, the Trump administration says that the other IDR plans now open are: Income-Based Repayment, Pay As You Earn and Income-Contingent Repayment.

The Education Department recently reopened those IDR plan applications, following a period during which the plans were unavailable. (The Trump administration said it was updating the plans’ applications to make them comply with the recent court order over SAVE.)

Borrowers should know that the automatic loan forgiveness after 20 or 25 years is not available at the moment under ICR or PAYE “since the courts have questioned that permissibility under statute,” Buchanan said.

Still, if a borrower enrolled in ICR or PAYE, then switches to IBR, their previous payments made under the other plans will count toward loan forgiveness under IBR, as long as they meet the plan’s other requirements, Buchanan said.

Meanwhile, borrowers in any of the three IDR plans can get credit toward PSLF.

If you’re on strong financial footing and not seeking loan forgiveness, the Standard Repayment Plan is a smart option for borrowers, experts say. Under that plan, the payments will usually be larger than on an IDR plan, but they’re fixed and borrowers are typically debt-free after just a decade.

Personal Finance

Here’s why ‘dead’ investors outperform the living

Published

2 days ago

April 5, 2025

Business Finance News

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“Dead” investors often beat the living — at least, when it comes to investment returns.

A “dead” investor refers to an inactive trader who adopts a “buy and hold” investment strategy. This often leads to better returns than active trading, which generally incurs higher costs and taxes and stems from impulsive, emotional decision-making, experts said.

Doing nothing, it turns out, generally yields better results for the average investor than taking a more active role in one’s portfolio, according to investment experts.

The “biggest threat” to investor returns is human behavior, not government policy or company actions, said Brad Klontz, a certified financial planner and financial psychologist.

“It’s them selling [investments] when they’re in a panic state, and conversely, buying when they’re all excited,” said Klontz, the managing principal of YMW Advisors in Boulder, Colorado, and a member of CNBC’s Advisor Council.

“We are our own worst enemy, and it’s why dead investors outperform the living,” he said.

Why returns fall short

Dead investors continue to “own” their stocks through ups and downs.

Historically, stocks have always recovered after a downturn — and have gone on to reach new heights every single time, Klontz said.

Data shows how detrimental bad habits can be relative to the buy-and-hold investor.

The average stock investor’s return lagged the S&P 500 stock index by 5.5 percentage points in 2023, according to DALBAR, which conducts an annual investor behavior study. (The average investor earned about 21% while the S&P 500 returned 26%, DALBAR said.)

The theme plays out over longer time horizons, too.

The average U.S. mutual fund and exchange-traded fund investor earned 6.3% per year during the decade from 2014 to 2023, according to Morningstar. However, the average fund had a 7.3% total return over that period, it found.

That gap is “significant,” wrote Jeffrey Ptak, managing director for Morningstar Research Services.

It means investors lost out on about 15% of the returns their funds generated over 10 years, he wrote. That gap is consistent with returns from earlier periods, he said.

“If you buy high and sell low, your return will lag the buy-and-hold return,” Ptak wrote. “That’s why your return fell short.”

Wired to run with the herd

Emotional impulses to sell during downturns or buy into certain categories when they’re peaking (think meme stocks, crypto or gold) make sense when considering human evolution, experts said.

“We’re wired to actually run with the herd,” Klontz said. “Our approach to investing is actually psychologically the absolute wrong way to invest, but we’re wired to do it that way.”

Market moves can also trigger a fight-or-flight response, said Barry Ritholtz, the chairman and chief investment officer of Ritholtz Wealth Management.

“We evolved to survive and adapt on the savanna, and our intuition … wants us to make an immediate emotional response,” Ritholtz said. “That immediate response never has a good outcome in the financial markets.”

These behavioral mistakes can add up to major losses, experts say.

Consider a $10,000 investment in the S&P 500 from 2005 through 2024.

A buy-and-hold investor would have had almost $72,000 at the end of those 20 years, for a 10.4% average annual return, according to J.P. Morgan Asset Management. Meanwhile, missing the 10 best days in the market during that period would have more than halved the total, to $33,000, it found. So, by missing the best 20 days, an investor would have just $20,000.

Buy-and-hold doesn’t mean ‘do nothing’

Of course, investors shouldn’t actually do nothing.

Financial advisors often recommend basic steps like reviewing one’s asset allocation (ensuring it aligns with investment horizon and goals) and periodically rebalancing to maintain that mix of stocks and bonds.

There are funds that can automate these tasks for investors, like balanced funds and target-date funds.

These “all-in-one” funds are widely diversified and take care of “mundane” tasks like rebalancing, Ptak wrote. They require less transacting on investors’ part — and limiting transactions is a general key to success, he said.

“Less is more,” Ptak wrote.

(Experts do offer some caution: Be careful about holding such funds in non-retirement accounts for tax reasons.)

Routine also helps, according to Ptak. That means automating saving and investing to the extent possible, he wrote. Contributing to a 401(k) plan is a good example, he said, since workers make contributions each payroll period without thinking about it.

Personal Finance

As recession risk jumps, top financial pros share their best advice

Published

3 days ago

April 4, 2025

Business Finance News

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There is at least a 60% chance of recession if Trump's tariffs stick, says JPMorgan's David Kelly

Meanwhile, J.P. Morgan raised its odds for a U.S. and global recession to 60%, by year end, up from 40% previously.

“Disruptive U.S. policies has been recognized as the biggest risk to the global outlook all year,” J.P. Morgan strategists said in a research note on Thursday.

Allianz’s Chief Economic Advisor Mohamed El-Erian also warned on Friday that the risk of a U.S. recession “has become uncomfortably high.”

‘There is some nervous energy’

“There is some nervous energy there,” said certified financial planner Douglas Boneparth, president of Bone Fide Wealth in New York, of the conversations he is having with his clients.

Even though stocks took a beating on Friday, “we advise them to focus on fundamentals and what they can control, which means maintaining a strong cash reserve and discipline around cash flow so that they can stay in the market and feel confident about taking advantage of buying opportunities,” said Boneparth, a member of the CNBC Financial Advisor Council.

Recession or not, maintaining a consistent cash flow and investment strategy is key, other experts say.

“The best way to manage these moments is to maximize your current and future selves is to block out noise that doesn’t apply to your plan,” said CFP Preston Cherry, founder and president of Concurrent Financial Planning in Green Bay, Wisconsin.

Letting emotions get in the way is one of “the greatest threats to life and money plans,” said Cherry, who is also a member of the CNBC Advisor Council.

When it comes to volatility tolerance, sharp drops in the market are to be expected, the advisors say.

“The stock market is unpredictable, but historically, there’s a trend in how the market recovers,” Cherry said.

“In years with market corrections and pullbacks, these are the worst days, which are followed by the best days,” he added.

In fact, the 10 best trading days by percentage gain for the S&P 500 over the past three decades all occurred during recessions, often in close proximity to the worst days, according to a Wells Fargo analysis published last year.

“Being out of the market and missing the best days and cycles after recessions significantly hurt portfolios in the long run,” Cherry said.

Boneparth said his clients also “know volatility and uncertainty is part of the game and, most importantly, know not to sell into chaos.”

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