April 15 is past, and there’s nothing you can do about the capital gains taxes you had to pay for last year.

But what about for the next 12 months?

No doubt you’re unhappy to have paid taxes on 2007 gains that, in many cases, disappeared in the first few months of 2008.

That might leave you thinking you should move your money into funds with lower turnover and higher tax efficiency.

But the most important thing to remember, and something I’ve said for years, is that it isn’t tax efficiency that investors should strive for, it’s after-tax returns. That is, earning as much as we can even after the IRS is done with us.

Because of all the losses the fund has sustained, Growth Equity (VGEQX) has the best five-year tax efficiency of any Vanguard fund, at 99.7%.

But that tax efficiency didn’t help the fund in the after-tax total return derby. It substantially underperformed its large-growth peers and generated a return that was below that of the stock market.

Are Indexes the Way to Go?

In a word: NO! First off, not all index funds are tax efficient. Second, those that are tax-efficient aren’t necessarily going to put more money in your pocket.

Over the last three years, for instance, one of Vanguard’s most efficient index funds, SmallCap Growth Index (VISGX), was losing just 1% of its total return to taxes. Yet, many funds with lower tax efficiency outperformed it on an after-tax basis.

Turn Away From Turnover

The old-think was that funds with low turnover, whose managers held on to stocks for years rather than months, were more tax-efficient than funds with higher turnover.

But not all turnover results in a taxable gain. Higher turnover could mean that a fund manager is harvesting his or her losses. Turnover is not the be-all, end-all indicator of tax efficiency.

The Best Funds for Tax-Year 2008

Enough of the talk. Just which Vanguard funds produce the best after-tax returns, and are they the same as the most tax efficient funds…

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As I do every year, I’ve just analyzed the three-year and five-year tax-adjusted returns for all Vanguard funds. I also go one step further and, besides using the current income and capital gains tax rates in my calculations, I incorporate reduced tax rates on qualified dividend income as specified under the 2003 Tax Act.

This year, given the losses sustained in the 2000 to 2002 bear market, many of which are still sitting on the books, it should come as no surprise that tax-efficiency remains fairly high across the board at Vanguard.

I told you about Growth Equity, but take a look at all the large-cap growth funds as a group. Among the worst, from a tax-efficiency standpoint: PRIMECAP (VPMCX).

Yet, the fund also had the highest after-tax return over the past five years at 102.8%. And my favorite Vanguard growth fund scores high on all counts, with five-year tax-efficiency of 96% and a tax-adjusted return of 133%.

Are the Tax-Managed funds really giving you the best bang for your buck?

Well, they’re tax-efficient. But my 2007-2008 special momentum pick, despite its lower 87% tax-efficiency, outpaced Tax-Managed International’s (VTMGX) index approach (97% tax-efficiency) over three years with tax-adjusted returns of 46.8%.

And it doesn’t stop there. Tax-Managed Capital Appreciation’s (VMCAX) 19.3% three-year after-tax return was better than Total Stock Market’s (VTSMX) 18.8% return over three years, but not over five.

Is it worth paying a higher minimum and being locked into a fund with a back-end load just for the tax-managed moniker and a fractional return advantage?

Get Rich by Paying Taxes

I think you get the point. In the final analysis, the most tax efficient funds aren’t necessarily the ones that leave you with the most money once you’ve paid your taxes.

That’s why I’ve posted the three-year and five-year tax efficiency for all of Vanguard’s funds to my website and analyzed which Vanguard funds have given investors the best after-tax returns.

As you’ll see, some funds might have made you pay more taxes, but they also left a lot more money in your pocket.

But not all of them will give you the best returns for 2008. I’ll tell you which Vanguard funds will give you the most bang for your 2008 tax dollar when you join me for a risk-free trial to my newsletter, The Independent Adviser for Vanguard Investors. Even better, I’ve just updated my Buy/Hold/Sell ratings on numerous funds due to a subtle shift I see taking place in the markets and the economy. Among others, I think it’s the perfect time to begin juicing your yields with one of Vanguard’s bond funds. Get your issue right here now!