Tax-Efficient Portfolios for Vanguard Investors

Most investors have the bulk of their assets in tax-sheltered retirement accounts, where they can earn a tax break on the way in (traditional, pretax accounts) or on the way out (Roth accounts), as well as tax-sheltered compounding.

But there are good reasons to hold assets in a taxable brokerage account, too. One of the key ones is if you’re saving and investing for goals other than retirement, such as a wedding, home down payment, or a lake house. If you need to crack into the account before you reach retirement age, you won’t have to face any strictures or tax penalties to do so.

Another smart reason people may turn to taxable, nonretirement accounts for savings is if they’re fully funding their retirement accounts but want to make additional investments above and beyond those accounts’ contribution limits. For high-income people, maxing out tax-sheltered retirement accounts might not be enough to help them maintain their standard of living in retirement.

The good news is that it’s possible to mimic the tax-sheltered compounding you get with a retirement account inside of a taxable brokerage account. I’ve developed 12 Vanguard portfolios—six for retirees and six for retirement savers—that aim to limit taxable income and capital gains distributions even when held in a taxable brokerage account. The portfolios consist of ETFs, index funds, and tax-managed funds for their equity exposure, and municipal-bond funds for their fixed-income exposure. The good news is that Vanguard fields excellent, low-cost options in all of those categories; nearly every holding in these portfolios earns a Morningstar Medalist Rating of Gold.

Note that tax management can only take you so far: While these portfolios aim to limit income and capital gains distributions during the investor’s holding period, they don’t aim to limit taxes when holdings are eventually sold. Thus, investors will want to consider timing sales of appreciated holdings to coincide with low-tax years, seek opportunities to engage in tax-loss selling, and tie highly appreciated securities into bequests in an effort to reduce the taxes due on appreciation.

Tax-Efficient In-Retirement Portfolios (Mutual Funds)

These portfolios are designed for retired investors’ taxable (nonretirement) accounts, so I chose holdings that have historically kept income and capital gains distributions low. I used Vanguard’s low-cost, no-nonsense municipal bond funds for fixed-income exposure and its tax-managed funds for equity exposure. However, investors could opt for total stock market index funds and exchange-traded funds for equity exposure instead, as they’ve been neck and neck with the tax-managed funds from the standpoint of tax efficiency over time. Investors in high tax brackets will want to consider using a municipal money market for their portfolios’ ongoing cash needs. All of these portfolios employ a bucket strategy. Retirees should use their own anticipated portfolio spending to determine which of these versions—Aggressive, Moderate, or Conservative—is the best fit given their situations. For example, the retiree who gets all of her cash flow needs from her required minimum distributions from her IRA may want to opt for the Aggressive version because she’s not actively spending from the taxable account.

Tax-Efficient In-Retirement Portfolios (ETFs)

Like the mutual fund portfolios above, these portfolios are meant to be held in investors’ taxable (nonretirement) accounts, and they employ a bucket framework. Because ETFs provide such broad exposure in a single package, the portfolios are all quite svelte, with five holdings apiece. As with the mutual fund portfolios, investors in these ETF portfolios will want to consider their own tax brackets to determine whether a municipal money market fund might be better on an aftertax basis than a taxable cash account.

Tax-Efficient Retirement Saver Portfolios (Mutual Funds)

In contrast with the Bucket portfolios above, these portfolios are geared toward people who are actively saving and investing for retirement and aren’t currently tapping their portfolios for living expenses. Their equity exposure consists largely of Vanguard’s tax-managed funds, whereas the bond exposure comes through municipal bond funds, whose income skirts federal income taxes. However, investors could opt for total stock market index funds and ETFs for equity exposure instead, as their tax efficiency has been close to that of the tax-managed equity funds over time.

Tax-Efficient Retirement Saver Portfolios (ETFs)

As with the mutual fund portfolios, these portfolios are designed with retirement savers’ taxable accounts in mind. In an effort to limit taxable distributions; they hold tax-efficient, broadly diversified equity ETFs and municipal-bond ETFs. As with the taxable ETF portfolios geared toward retirees, these portfolios are ultraminimalist.