Tax-efficient investing should always be a priority in asset placement across accounts and in subsequent fund selection, especially for high-income investors. Why give up money to Uncle Sam unnecessarily if you don't have to? Minimizing your portfolio's tax burden means maximizing its long-term total return. Here we'll explore tax-efficient fund placement and the best ETFs for taxable accounts.
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In a hurry? Here's the list:
- IVV – iShares Core S&P 500 ETF
- ITOT – iShares Core S&P Total U.S. Stock Market ETF
- IXUS – iShares Core MSCI Total International Stock ETF
- VUG – Vanguard Growth ETF
- VTEB – Vanguard Tax-Exempt Bond ETF
- VGIT – Vanguard Intermediate-Term Treasury ETF
Contents
Video
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Introduction – Creating a Tax-Efficient ETF Portfolio
Whether it's for shorter investing horizons, income investing, or retirement account spillover, investing in taxable accounts is unavoidable sometimes. It's usually a good problem to have.
Tax-inefficient assets, best held in tax-advantaged space like an IRA, would be things like high-dividend-yield stocks or funds, REITs, metals (taxed as collectibles), and actively managed funds. Dividends and capital gains distributions are taxed when they're paid. REITs are required to distribute nearly all their income, usually at the non-qualified dividend rate. Actively managed funds have what's called high turnover – they are constantly buying and selling securities within the fund. Bond funds are also relatively tax-inefficient, but interest from treasury bonds is exempt from state taxes.
ETFs are particularly attractive for tax-efficient investing in a taxable brokerage account, but not all ETFs are created equally. Specifically, we're looking for ETFs with tax-efficient structure, passive management, low turnover, low capital gains distributions, low fees, and low dividend yield. Among these options are broad core stock funds, Growth stock funds, treasury bonds, and municipal bonds.
The Best ETFs for Taxable Accounts
Let's dive into the 6 best ETFs for taxable accounts.
IVV – iShares Core S&P 500 ETF
IVV from iShares tracks the S&P 500 index, which is composed of 500 of the largest companies in the United States. The fund has an expense ratio of 0.03%.
ITOT – iShares Core S&P Total U.S. Stock Market ETF
To add exposure to small- and mid-caps, you might go with a total market ETF. ITOT from iShares is a low-cost option to access the total U.S. stock market. The fund contains over 3,500 stocks and has an expense ratio of 0.03%.
IXUS – iShares Core MSCI Total International Stock ETF
International stocks usually carry a higher dividend yield than U.S. stocks, but this is balanced out somewhat by the foreign tax credit, a credit to individuals who pay taxes on foreign investment income. This makes international stock funds reasonably tax-efficient. Just like ITOT, IXUS is a low-cost option to get exposure to a broad total market, in this case ex-US stocks. The fund tracks the MSCI ACWI ex USA IMI Index and has an expense ratio of 0.09%.
VUG – Vanguard Growth ETF
Prefer Growth stocks or want a Growth tilt for your portfolio? You're in luck. Growth stocks have low or no dividend yield, making them ideal for a taxable environment where a high yield creates a larger tax burden. The Vanguard Growth ETF tracks the CRSP US Large Cap Growth Index, which is comprised of large-cap stocks that exhibit growth characteristics. The fund has an expense ratio of 0.04%.
VTEB – Vanguard Tax-Exempt Bond ETF
Bond funds are usually best kept in tax-advantaged accounts. But if you want bonds in your taxable account, some are more tax-efficient than others. Interest from municipal bonds is tax-free at federal, state, and local levels. This is especially impactful for high-income investors in a higher tax bracket. VTEB is Vanguard's municipal bond index fund, which tracks the S&P National AMT-Free Municipal Bond Index. The ETF has an expense ratio of 0.06%.
VGIT – Vanguard Intermediate-Term Treasury ETF
Similarly, interest from treasury bonds is tax-exempt at state and local levels. Treasury bonds tend to possess a lower correlation to stocks than municipal bonds, making them a likely superior hedge. Vanguard's Intermediate Term Treasury ETF tracks the Bloomberg Barclays U.S. Treasury 3–10 Year Bond Index. The fund has an expense ratio of 0.05%.
Where to Buy These Tax-Efficient ETFs
M1 Finance is a great choice of broker to buy the aforementioned ETFs in your taxable account. It has zero transaction fees and offers fractional shares, and a modern, user-friendly interface and mobile app.
Most importantly in this context, the broker features automatic rebalancing, which directs new deposits to underweight assets according to your specified allocations, so that you don't have to manually rebalance and pay taxes unnecessarily. Moreover, M1 features built-in tax optimization, selling any losses to offset gains first, followed by your oldest tax lots, in order to minimize capital gains taxes.
M1 also offers some of the lowest margin rates if you want to employ leverage in your taxable account to enhance exposure. I wrote a comprehensive review of M1 Finance here.
Canadians can find the above ETFs on Questrade or Interactive Brokers. Investors outside North America can use eToro or possibly Interactive Brokers.
Disclosures: None.
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Disclaimer: While I love diving into investing-related data and playing around with backtests, this is not financial advice, investing advice, or tax advice. The information on this website is for informational, educational, and entertainment purposes only. Investment products discussed (ETFs, mutual funds, etc.) are for illustrative purposes only. It is not a recommendation to buy, sell, or otherwise transact in any of the products mentioned. I always attempt to ensure the accuracy of information presented but that accuracy cannot be guaranteed. Do your own due diligence. I mention M1 Finance a lot around here. M1 does not provide investment advice, and this is not an offer or solicitation of an offer, or advice to buy or sell any security, and you are encouraged to consult your personal investment, legal, and tax advisors. All examples above are hypothetical, do not reflect any specific investments, are for informational purposes only, and should not be considered an offer to buy or sell any products. All investing involves risk, including the risk of losing the money you invest. Past performance does not guarantee future results. Opinions are my own and do not represent those of other parties mentioned. Read my lengthier disclaimer here.
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Although it’s a mutual fund, would you include FXAIX too?
Which global ETF is most tax efficient? VT, SPGM or?
Not sure. Probably splitting hairs.
Why IVV instead of VOO?
VOO is fine too! I just used it on other lists so didn’t want to repeat too much.
Hi,
This is good information for taxable ETF portfolio. What do you consider a high dividend percentage ETF to avoid in a taxable account? Would a mix of VUG and VTV be a good combination to be in a taxable account, I’m planning to get rid of the VNQ ETF in my portfolio because of the dividend distributions. Please advise.
Thanks,
JB
Thanks, Jason. Tax efficiency is a sliding scale, not an on-off switch. The ideal setup would be zero dividend yield in taxable space, but of course that may be unrealistic. Vanguard has a good page on tax efficiency of different asset types here.
…just wanting to verify opinion… did you say VGIT on a taxable side or in a deferred or exempt vehicle?
Not that black and white. Tax efficiency is a sliding scale. Stocks are more tax-efficient than bonds. But treasuries are more tax-efficient than corporates.
Is there anything that makes the iShares funds more tax efficient than Vanguard funds?
No. I just like to introduce some variety here and there.
What are your thoughts on MUB or Muni bond ETFs as the basis of the fixed income component of a taxable account? Duration is roughly similar to VGIT. Both have low credit risk. Thanks.
Possibly good if you’re in a high tax bracket but they don’t provide much downside protection.
I like your choices for taxable – they’re tax efficient and you don’t want to be constantly re-balancing and churning investments in a taxable account, it’s a significant tax drag. A lot of investors who picked their favorite actively managed funds in taxable account learned that lesson.
I think Avantis US Equity ETF – AVUS – is another option, covering broad US market with some factor tilt and should still be quite tax-efficient. Avantis talks about low turnover and trading strategies to help keep it tax efficient.
The DFA ETFs that you recently wrote about could also be considered. And as you alluded to – DFUS used to be their Tax-Managed Mutual Fund equivalent before converting to an ETF.
DFAC – US Core Equity 2 – provides some more value/small tilt and is “Tax Aware” – so it does consider tax-efficiency in trying to provide the factor tilts.
So some options there for pretty good tax efficient ETFs if someone wanted some light to moderate small/value/profitability factor tilt.
I’m curious as whether you considered NTSX (and now NTSI/NTSE by extension) for this list?
Since you’ve noted elsewhere that you hold it in your taxable.
Additionally, I’m curious as to whether you recommend balancing tax efficiency and diversification in taxable funds, and if so, what to keep in mind for the balancing.
Currently, I’m considering a 50/25/25 split between NTSX, NTSI, and NTSE for taxable (I’m hoping NTSI and NTSE become more popular/liquid going forward).
Relying solely on large cap blends makes me want more diversification, but I’m not a fan of growth at current valuations. And I’m hesitant to add something like AVUV/AVDV/AVEM due to their tax inefficiency, and rebalancing being tax prohibited.
NTSX would work too. I honestly don’t remember if I even knew it existed when I first wrote this post.
Yea, tax efficiency and asset class diversification will be somewhat of a tradeoff, especially with something like gold, and should, as always, depend on the investor’s time horizon and risk tolerance.
If your expected premium from a Value fund outweighs the tax implications, it might still be sensible. Or ideally, balance out Growth positions in taxable with Value positions in tax-advantaged accounts, if you wanted to separate the styles that way.
If you find a broker like M1 that does automatic rebalancing from new deposits, you won’t have to sell shares to rebalance provided the deposits are sufficiently large to correct misallocations.
Just wanted to give you a shout out. Great website. There is a wealth of knowledge here that I just discovered today. Appreciate all the hard work.
Wow, thanks for the kind words, Reid! Glad you’ve found it useful so far. Comments like yours keep me going!
I became aware of tax efficiency only recently,I have Vanguard US Growth Fund VWUAX in taxable account,is there an equivalent ETF in Vanguard or other?Or just stay with the fund?
Not sure if there’s an ETF equivalent for that mutual fund. VUG might be the closest. Best to contact Vanguard and ask them.
Hi. Love your website, Can you show us your recommendation of what ETFs and allocation to put into a taxable account? Thanks a lot.
Thanks for the kind words! I can’t prescribe an exact asset selection and asset allocation, but if you can choose an asset allocation based on this post, a simple, globally diversified, 3-fund combination would be a total U.S. stock market index fund like ITOT above, a total international stock market fund via IXUS, and an intermediate treasury bond fund like VGIT mentioned above. An example for an 80/20 allocation would be 60/20/20 ITOT/IXUS/VGIT. You could also use a Value tilt in your tax-advantaged space and a Growth tilt in taxable using VUG to be more tax-efficient.
Hope this helps! Happy holidays!
Great thanks. I already have my tax-deferred account setup (Roth IRA). I was just looking for ideas for my taxable account for the most tax-efficiency. I was thinking a Growth ETF like VUG, but I just wasn’t sure. I already have VGIT in my Roth. Hopefully, this idea makes sense. I am just trying to the most tax-efficient as possible.
Then yes, exactly; you were on the right track. Maximizing tax efficiency would be using VUG in taxable and VTV in the Roth.
What is your take on Vanguards Mega Cap Growth ETF (MGK) for taxable accounts?
Hey Michael, that would be a good one for taxable accounts too. Similar to VUG.