I have money investing in a Fidelity 205x target date fund and my plan is to just let it sit for 20-30 years (it seemed the most obvious fund to get if I wanted automated long term investing with decreased risk over time); this is in a regular individual taxable account. But after [reading about the surprise tax bill](https://www.cnbc.com/2022/03/15/vanguard-created-big-tax-bills-for-target-date-fund-investors-lawsuit-claims.html) some Vanguard customers received with their own target date fund, I’m wondering if I need to act and sell everything and instead buy some ETFs, or if I need to do some other action, to potentially avoid a large surprise tax bill in the future.
I also need to consider that by selling, I’ll be getting a capital gains tax bill anyways, though I haven’t figured out what that might be, exactly. So ultimately, I’m trying to determine what I should do, if anything.
One thing to understand with the whole vanguard thing is that all that happened is people were forced to realize some capital gains, likely before most of the people wanted to. That CG distribution did lower share price accordingly, which will result in less taxes in the future when the person sells their shares.
As such, the harm of what happened is being vastly over blown. The harm isn’t that CGs we’re distributed, but that the people lost some control of that transaction.
This isn’t to say you should or shouldn’t change course here. Mostly just trying to help correct some of the inaccurate nuance of the situation.
Generally, a TDF shouldn’t be in a taxable account.
So first, we have to understand WHY target date funds are considered tax inefficient (relevant in a taxable brokerage account).
What is a TDF composed of?
Basically Total market Stocks and Total market Bonds right?
Now have a look at this. Look at the picture.
* https://www.bogleheads.org/wiki/Tax-efficient_fund_placement#Tax_efficiency_of_various_asset_classes
Look where Total Market Index funds fall.
Look at where Total Bond index funds fall.
So the reason the TDFs are inefficient owes in part due to the bonds portion. The bond distributions are taxable. As time goes on and the fund slowly increases bonds, you’ll have increasing tax inefficiency.
So that’s one way that *in general* TDFs are tax inefficient.
The other way is from random events as described in your article. That event is technically a “one off” sort of thing. But it is indeed possible that Fidelity changes something and the TDF experiences a similar capital gains distribution and subsequent taxable consequence.
So with all this in mind, you really need to go back to the “Why” behind your selection of a TDF. Generally, it’s a good selection if you want a one fund, hands off, no thinking, solution. Sure, it may cost some degree of tax inefficiency, but that is a part of something that just needs to be acknowledged in exchange for the convenience.
Sure, it would be *more* efficient to manage your own portfolio and rebalance the individual funds. But that does require some degree of attention.
Are you getting that it’s basically about trade offs yet?
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