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7 Best Mutual Funds to Keep Taxes Low

These diverse funds have the best qualities for keeping taxes low

By Kent Thune, InvestorPlace Contributor

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When looking for the best mutual funds to buy for a taxable account, it’s smart to search for more than just the top performers — you’ll want to find the best funds that can also keep taxes low.

So what qualities does one look for in a fund when they want to minimize taxes? The most tax-efficient funds tend to be the ones with the lowest yields and the lowest turnover.

The low-yield quality is obvious because less dividends or interest generally means less taxes to the investor. This means that growth stock funds are generally more tax-efficient than value stock funds.

Low turnover is a tax-efficiency quality because mutual funds that do more buying and selling will typically produce more capital gains. And mutual funds are required to distribute 95% of their capital gains to shareholders. So investors can get hit with taxes on mutual funds even if they did no buying or selling of their own!

So, if you have a taxable account, you’ll want to check out these seven best funds to keep taxes low.

Best Funds to Keep Taxes Low: Vanguard Total Stock Market Index (VTSMX)

Best Funds to Keep Taxes Low: Vanguard Total Stock Market Index (VTSMX)Expenses: 0.17%, or $17 for every $10,000 invested
Minimum Initial Investment: $3,000

There aren’t many mutual funds that are cheap, tax-efficient, and diversified, all in one package but, Vanguard Total Stock Market Index (VTSMX) is one of those funds.

VTSMX holds about 3,700 stocks but has an extremely low turnover ratio of 3%, which means there’s very little trading activity in the portfolio that can generate taxable, capital gains distributions to shareholders.

The fund does hold mega-cap stocks, such as Apple Inc. (AAPL), Microsoft Corporation (MSFT), and Exxon Mobil Corporation (XOM), which will kickoff some dividends, but the 1.91% yield for VTSMX is mild enough to keep taxes from those dividends lower than most funds with similar holdings.

Best Funds to Keep Taxes Low: USAA NASDAQ-100 Index (USNQX)

Best Funds to Keep Taxes Low: USAA NASDAQ-100 Index (USNQX)Expenses: 0.59%
Minimum Initial Investment: $3,000

Index funds and growth funds tend to be the best funds for minimizing taxes and USAA NASDAQ-100 Index (USNQX) combines both of those tax-efficient features.

By nature, growth stocks generate very little to no dividends. Companies in the growth category tend to reinvest their cash, rather than sharing it with investors in the form of dividends. Therefore, growth stock mutual funds are generally more tax-efficient than value stock mutual funds.

USNQX does a good job of tracking the growth stock-rich NASDAQ-100 Index, which includes large tech firms like Alphabet inc (GOOG, GOOGL) and Facebook Inc (FB), and big bio-technology stocks like Gilead Sciences, Inc. (GILD) and Amgen, Inc. (AMGN).

In addition to growth and minimal taxes, USNQX is a five-star fund that ranks in the top 1% among large-cap growth funds for the three-, five- and 10-year returns.

Best Funds to Keep Taxes Low: Vanguard Tax-Managed Capital Appreciation (VTCLX)

Best Funds to Keep Taxes Low: Vanguard Tax-Managed Capital Appreciation (VTCLX)Expenses: 0.12%
Minimum Initial Investment: $10,000

Actively-managed funds can be tax-efficient and Vanguard Tax-Managed Capital Appreciation (VTCLX) is one of the best funds to prove it.

VTCLX does track the Russell 1000 Index, but the management focuses on securities in the index that pay lower dividends. This helps to minimize taxable gains and dividend income. So shareholders of VTCLX get the tax-efficient benefits of index funds while potentially minimizing taxes further with the help of professional management.

One slight drawback is that the minimum initial investment is $10,000 (Vanguard doesn’t offer this fund in the cheaper Investor share class), but VTCLX can make an outstanding core holding for a taxable account, which means investors may be able to allocate a larger amount to a quality fund like this.

Best Funds to Keep Taxes Low: USAA World Growth Fund (USAWX)

USAA-185Expenses: 1.17%
Minimum Initial Investment: $3,000

A combination of a growth objective and low turnover combine to make USAA World Growth (USAWX) one of the best funds to buy for taxable accounts.

USAWX invests in both foreign and domestic stocks, which gives the fund a diversified mix of equities around the globe. Top holdings in the portfolio include Thermo Fisher Scientific (TMO), Walt Disney Co (DIS), and Nestle (NSRGF).

Not only is USAWX tax-efficient, it’s also a strong performer. For example, the 10-year annualized return is 6.5%, which beats 97% of world stock funds, and the 10-year tax-adjusted return is 6.0%, which beats 98% of world stock funds. And turnover for the fund is just 9%.

Best Funds to Keep Taxes Low: Vanguard High-Yield Tax Exempt Fund (VWAHX)

Best Funds to Keep Taxes Low: Vanguard High-Yield Tax Exempt (VWAHX)Expenses: 0.20%
Minimum Initial Investment: $3,000

If you’re looking for a bond fund that can produce decent yields but keep taxes to a minimum, Vanguard High-Yield Tax Exempt (VWAHX) makes an outstanding choice.

Income from municipal bonds are tax-free at the federal level and investors with taxable accounts are wise to look into the benefits of municipal bond funds like VWAHX.

Income may also be exempt from state and local taxes for investors who reside in the issuing state. For example, investors living in New York, where there is a state tax, may want to consider buying a New York municipal bond fund instead of national municipal bond funds like VWAHX.

Performance for VWAHX is also a plus. It consistently ranks in the top 5% of municipal bond funds for three-, five- and 10-year returns.

Best Funds to Keep Taxes Low: Vanguard Small Cap Growth Index (VISGX)

Best Funds to Keep Taxes Low: Vanguard Small Cap Growth Index (VISGX)Expenses: 0.23%
Minimum Initial Investment: $3,000

We’ve covered the fact that index funds and growth funds are generally more tax-efficient than actively managed funds and value funds, respectively. But we’ve not yet mentioned that small-cap stock funds are often more tax-efficient than large-cap funds. Vanguard Small Cap Growth Index (VISGX) covers all three of these bases.

The turnover ratio is just 23%, which is low for a small-cap stock fund, and the growth objective keeps dividends on the low end. The 10-year tax-adjusted return of 6.5% beats 96% of small growth stock funds.

So if you want to add an aggressive tax-efficient fund to your taxable account portfolio, VISGX is a smart choice.

Best Funds to Keep Taxes Low: Vanguard Tax-Managed Balanced (VTMFX)

Best Funds to Keep Taxes Low: Vanguard Tax-Managed Balanced (VTMFX)Expenses: 0.12%
Minimum Initial Investment: $10,000

If you’re looking for one-fund solution or a solid core holding for a taxable account, Vanguard Tax-Managed Balanced (VTMFX) is one of the best funds to buy.

The portfolio normally maintains an asset allocation of roughly 50% stocks, which are mid- and large-capitalization, and 50% bonds. The fund seeks to keep taxes to a minimum by focusing on stocks with low dividend income and federally tax-exempt municipal bonds.

The combination of low expenses, tax-efficiency and smart management makes VTMFX a top-performing fund. The one-, three-, five- and 10-year tax-adjusted returns all rank in the top 1% among its conservative allocation category peers.

As of this writing, Kent Thune did not hold a position in any of the aforementioned securities. However, he holds VTSMX for some client accounts. Under no circumstances does this information represent a recommendation to buy or sell securities.


Article printed from InvestorPlace Media, https://investorplace.com/2016/04/7-best-mutual-funds-to-keep-taxes-low/.

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