Mike Quinn does his own taxes.
He pores over IRS Publication 17, a guide for individual filers, with the zeal of a certified public accountant, and he meticulously calculates how much money to set aside each April.
But this year came with a stinging surprise -- a tax bill roughly $30,000 more than he anticipated. That’s because Quinn, an independent contractor from New Jersey, owned two Vanguard Group retirement funds that racked up massive capital gains -- an increase of more than 2,000% from the prior year -- that fell almost entirely on the shoulders of unsuspecting individual investors.
Quinn, 56, is just one of potentially tens of thousands of Vanguard clients stuck with significantly higher tax bills this year because of a change the firm made to its target-date funds in late 2020, according to a class-action lawsuit filed March 14 in federal court in Philadelphia.
“I put faith in these guys for 20 years and lived through a couple of their foibles after Jack Bogle,” Quinn said, referring to Vanguard’s legendary founder, who died in 2019 and left a legacy built on lowering costs for retail investors. “This one was just too much.”
The Valley Forge, Pennsylvania-based company has a cult-like following among do-it-yourself savers, some of whom have voiced disappointment with customer service in recent years.
The tax debacle threatens to further erode that well of goodwill.
In December 2020, Vanguard made changes to its target-date funds, which allow investors to choose a year when they plan to retire and then let the firm handle the rest — changing a fund’s asset mix to gradually become more conservative as the target date approaches. Indeed, Bogle embraced an investing philosophy of “set it and forget it” — tailored to investors with neither the time nor inclination to actively manage their own portfolios.
Vanguard had two classes of funds — lower-fee institutional funds and more costly retail funds. Seeking to stay competitive against other large asset managers, the firm lowered the institutional funds' minimum investment for retirement plans to $5 million from $100 million.
That triggered an “elephant stampede” — as Wall Street Journal columnist Jason Zweig described it — with money pouring out of the retail funds and into the lower-fee institutional funds, forcing Vanguard to sell assets from the retail funds. Assets at Vanguard’s 2035 target fund dropped $8 billion to $38 billion, and they fell by $7 billion to $29 billion in the 2040 fund.
While institutions and other investors with tax-advantaged accounts such as 401(k)s and IRAs weren’t adversely affected, the resulting capital gains fell on the pool of retail investors with taxable accounts who remained in the higher-fee funds.