Each year, tax time catches some investors off guard. If you’re holding a diversified ETF like VDGR or VDHG, you might be one of them.
What are Vanguard’s diversified ETFs: VDHG and VDGR
Vanguard Diversified High Growth Index ETF (VDHG) and Vanguard Diversified Growth Index ETF (VDGR) are two ETFs managed by Vanguard Australia. Both are multi-asset ETFs, meaning they hold a diversified mix of domestic and international shares, as well as fixed income investments.
These products are popular for good reason. They offer broad exposure, low fees, and are easy to buy through any online stock broker. But there’s a lesser-known tax trap built into them that many investors only discover when their tax return lands.
Vanguard ETF tax: VDHG and DHHF hidden tax costs
Under the hood, these diversified ETFs aren’t like others. Rather than holding listed ETFs, they’re built from unlisted managed funds. While this may not sound like a big deal, it can make a significant difference at tax time.
Here’s why: when investors exit an unlisted fund, the manager often needs to sell assets to meet redemptions. This realises capital gains, which are passed on to all remaining investors, even if they didn’t sell anything. So yes, you could be paying tax because someone else decided to cash out.
The tax drag is real
Distributions from these funds can quietly eat away at your long-term compounding potential. Unlike ETFs that use in-kind redemptions to manage outflows efficiently, unlisted funds trigger capital gains that show up in your end-of-year tax statement.
And the impact adds up. A Morningstar simulation found that increasing annual distributions from 1% to 2% on a portfolio earning 8% per year reduced the final balance by up to $175,000 over 30 years for a higher-income investor. Even smaller investors saw a drag of $50,000 to $77,000.
That’s money lost to the taxman – money that could have been compounding quietly in your portfolio.
VDGR’s extra tax hits don’t stop there
Many of the unlisted funds inside VDGR and VDHG also use currency hedging through forward contracts. These are taxed as ordinary income, not capital gains. That means:
- You pay tax on the full amount
- You can’t use the 50% capital gains tax discount
- You pay tax immediately, with no ability to defer
Even if the underlying investment didn’t grow in value, these hedging instruments can increase your tax bill.
VDHG vs DHHF or automated investing. What are your options?
If you’re investing outside of super, the structure of your investments matters more than many people realise. If tax efficiency is something you care about, there are a few alternatives worth considering.
- You could build your own portfolio using listed ETFs. But that means doing the work to choose the right mix, stay on top of tax reporting and regularly rebalance to keep your risk on track.
- There are also listed diversified ETF options like DHHF or DGGF. These avoid unlisted managed funds, but their asset mix is different from Vanguard’s. Some, like DGGF, have an ethical tilt, which may or may not suit your goals.
- Or you could use an automated service like Stockspot. Our portfolios are built entirely from listed ETFs, designed to be tax-efficient and easy to manage, without the hassle of doing it all yourself.
Tax isn’t everything, but it does matter
To be fair, not every investor will feel the same impact. If you’re in a lower tax bracket, or you’re holding these funds within super, the tax drag may be smaller. And there’s no denying the convenience of set-and-forget products like VDGR or VDHG. For some, that simplicity outweighs the tax cost.
Vanguard did announce in 2024 that they’re starting to convert these funds to improve the ETF tax-efficiency. But it’s a slow process. As of September 2024, only 2.2% of VDHG had moved across. So most of it is still invested in unlisted managed funds.
A final comment on VDHG and VDGR
If you’ve noticed surprise capital gains popping up in your tax return each year, it’s worth digging a little deeper into what you actually own.
At Stockspot, we focus on after-fee, after-tax returns because that’s what really matters. That’s why we avoid unlisted managed funds altogether and stick with listed ETFs that are built to reduce tax drag and help you grow your wealth over the long run.If you want to learn more about this topic, Morningstar wrote a detailed article on the Vanguard diversified funds including VDHG and VDGR here.
