Vanguard funds are widely known for their market efficiency and their cost efficiency, but they are also among the most tax-efficient investment vehicles available today.
Now that tax time is upon us, you may be looking at your 1099 form with some combination of disbelief, disgust and perhaps a bit of surprise. This may be because, when you invest in mutual funds, you can actively select your own funds but you have no control over how the fund is managed.
For example, the fund manager can buy securities that kick off dividends or they may sell holdings with significant gains, which are then passed along to you, the investor, in the form of capital gains distributions.
Tax-efficiency is a simple matter of keeping tax costs to a minimum, which is also a key aspect of achieving superior long-term returns. When you keep more of your money to yourself, rather than giving a portion to the government in the form of taxes, you are thus enabled to build wealth more effectively.
So the best way to keep tax costs low with mutual funds is to buy the ones that are the most tax-efficient. And with that, I give you the best tax-efficient Vanguard funds.
Best Tax-Efficient Vanguard Funds: Vanguard Total Stock Market Index (VTSMX)
If you want a low-cost, diversified stock mutual fund that is highly tax-efficient, you can’t get much better than Vanguard Total Stock Market Index Fund (MUTF:VTSMX).
VTSMX gives you very broad exposure to the U.S. stock market, including top holdings like Apple Inc (NASDAQ:AAPL), Exxon Mobile Corporation (NYSE:XOM) and Google Inc (NASDAQ:GOOG). Top sectors include financials at 19%, technology at 16% and health care at 14%.
Because of their passive nature, index funds tend to be among the most tax-efficient. With only 4% turnover, VTSMX generates very little in the way of capital gains. And with a yield of 1.7%, taxes on dividends aren’t significant.
Long-term investors, which comprise a large portion shareholders of Vanguard funds, will be happy with the tax-adjusted annualized 10-year return of 7.6% for VTSMX, which ranks ahead of 92% of funds in the large blend category.
In addition to the tax-efficiency, you’ll get cost-efficiency with a cheap expense ratio of 0.17%. The minimum initial purchase for VTSMX is $3,000.
Best Tax-Efficient Vanguard Funds: Vanguard Intermediate-Term Tax Exempt (VWITX)
Relative to actively-managed bond funds, you could do well to find tax-efficiency in any of Vanguard’s passively-managed bond funds but if you want the best combination of tax-free investing and decent returns, Vanguard Intermediate-Term Tax Exempt Fund (MUTF:VWITX) is an outstanding choice.
VWITX is a municipal bond fund, which means that the underlying holdings are municipal bonds or “munis” which provide income that is exempt from taxation at the federal level.
This income may also be exempt from state and local taxes for investors who reside in the issuing state or municipality. A New York City bond, for example, would be triple-tax-free (exempt from federal, state, and local taxes) for an investor living in New York City.
Vanguard does offer many municipal bond funds that hold bonds issued exclusively from various states, but VWITX holds a diverse mix of municipal bonds from a combination of cities and states across the United States. Therefore, this fund is tax-exempt at the federal level but not state.
Being an intermediate-term bond fund, VWITX offers returns generally better than that of short-term bond funds but without the interest rate risk of long-term bond funds.
The expense ratio is cheap at 0.2% and the minimum initial investment amount is $3,000.
Best Tax-Efficient Vanguard Funds: Vanguard Tax-Managed Balanced Fund (VTMFX)
If you’re looking for the best of conservative Vanguard funds for your taxable brokerage account, Vanguard Tax-Managed Balanced Fund (MUTF:VTMFX) is your fund.
On a tax-adjusted basis (measured by tax-cost ratio), VTMFX ranks in the top 1% of the conservative allocation funds for one-, three-, five- and 10-year returns.
The 15-year total annualized return of 5.3% for VTMFX even beats that of the S&P 500 Index (5%) for the same period. That’s an outstanding accomplishment for conservative fund that, at around 50% stocks and 50% bonds, is also extremely tax-efficient!
The expense ratio is a rock-bottom 0.12% although you’ll need to come up with $10,000 for a minimum initial investment — a worthwhile chunk to put up for a beautifully boring, balanced fund from Vanguard.
As of this writing, Kent Thune did not hold a position in any of the aforementioned securities. Under no circumstances does this information represent a recommendation to buy or sell securities.
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