25 Tax Managed ETFs and Mutual Funds - M* Article

Comments

• Mona

  February 17 edited February 17

  @bee, my taxable portfolio is considerably larger than my retirement portfolio. Unfortunately, I started somewhat late in constructing a tax-efficient taxable account.
  
  For domestic equities, I am concentrated in VTI/VTSAX (capital appreciation), VO/VIMAX (capital appreciation), and VIG/VDADX (capital appreciation). For international exposure, I hold VEA/VTMGX (capital appreciation). For income, I use VMLTX, VWIUX, and VWALX.
  
  In building a tax-efficient portfolio, I would use only index funds rather than actively managed funds. However, I currently hold two managed funds that have performed poorly over the past several years while generating significant capital gains distributions. I am reluctant to sell them because of the unrealized capital gains accumulated over many years of ownership. I probably should bite the bullet and sell these two funds.
• Observant1

  February 17 edited February 17

  An ETf which tracks a broad-based index like the S&P 500 or total stock market could be a good foundation.
  Vanguard's index mutual funds are just as tax-efficient as their ETf counterparts—Vanguard had a patent
  (now expired) which allowed the firm to offer ETFs as a separate share class of OEFs.
  Be careful when mixing, for example, small-cap and large-cap funds
  from different index providers (e.g., Russell, S&P, CRSP) to avoid overlap.
  
  Vanguard also offers several tax-managed funds.
  Vanguard Tax-Managed Capital Appreciation (VTCLX) closely resembles the Russell 1000.
  Vanguard Tax-Managed Small Cap (VTMSX) closely resembles the S&P 600.¹
  Since both funds are managed with tax-efficiency in mind and deviate slightly
  from their corresponding indexes, they are considered to be actively managed.
  
  
  
  ¹ I own this fund.
• WABAC

  February 17

  Foreign large cap value etf from DFA. https://www.morningstar.com/etfs/ARCX/DFIV/quote

  The investment seeks to achieve long-term capital appreciation while minimizing federal income taxes on returns. The Advisor buys and sells securities for the Portfolio with the goals of: (i) delaying and minimizing the realization of net capital gains (e.g., selling stocks with capital losses to offset gains, realized or anticipated); and (ii) maximizing the extent to which any realized net capital gains are long-term in nature (i.e., taxable at lower capital gains tax rates). The fund is designed to generally purchase securities of large non‑U.S. companies in countries with developed markets that the Advisor determines to be lower relative price stocks.
• msf

  February 17

  If you like VTMSX, another fund in the same SC Blend space to consider is FSMD (Fidelity Small/Mid Multifactor). Both funds hold around 600 securities and they have similar tax efficiency ratios - 0.40% and 0.44% respectively. Similar trailing twelve month yields too, 1.21% and 1.29% respectively.
  
  VTSMX is a bit smaller cap ($3.5B avg market cap vs. $6.7B) which might account for their virtually zero overlap.
  
  FSMD's risk score is lower (82 vs 92) and volatility is lower (15.3 vs. 19.1) perhaps due to cap size. FSMD has tended to have somewhat better returns, though this varies by year. FWIW, which I think is little, M* rates it gold vs. silver for the Vanguard fund. Its turnover is higher but still modest (38%) and shouldn't be a significant factor for an ETF.
  
  At various times I've owned each of these (but not both at the same time).
• bee

  February 18 edited February 18

  Thanks everyone. I appreciate all the responses.
  
  I recall USBLX using a similar tax managed strategy as VTMFX by investing in munis bonds. @msf or @observant1, do you know if the small cap funds, VTMSX or FSMD, are managed similarly?
  
  I would like to consider Non-US ETFs or mutual funds such as @WABAC suggested, but wonder if other taxes (foreign tax reporting) get triggered.
• msf

  February 18

  do you know if the small cap funds, VTMSX or FSMD, are managed similarly?
  
  In a narrow sense, yes. They are both managed to track their respective benchmark indexes. And those indexes cover roughly similar segments of the US market. VTMSX tracks (give or take minor tax tweaks) the S&P 600® that fishes in a pool of small cap stocks. FSMD tracks a Fidelity-proprietary index that fishes in a pool of small and mid cap stocks.
  
  In a broader sense, looking beyond how the funds are managed (more or less passively) to how their respective benchmarks are constructed, they are managed differently. The S&P 600 index is decided by committee, is market cap weighted, and notably excludes companies that are not profitable. IMHO that last point makes it appealing in the small cap space where many companies never make profits. It may also be why the index has a significant value bias.
  
  The selection and weightings of stocks in the Fidelity Small-Mid Multifactor Index ℠ are mechanical (rules-based) and based upon on four factors: valuation, quality, momentum, and volatility. This tends to give it a slight value bias (though less than the S&P 600) and apparently lower volatility. Its sector weights are adjusted so that they roughly track the market sector weights, as do the weights in the S&P 600.
  
  Each of these indexes makes adjustments to pure market cap weights in ways that seem, well, comforting.
  
• yogibearbull

  February 18

  VTMFX has "Balanced" in its name and it does that through munis.
• bee

  February 18

  @yogibearbull,
  
  Good point. USBLX is a Balance fund using munis on the bond side as well. These other tax managed funds are all equity.
• bee

  February 18 edited February 18

  @yogibearbull,
  
  Good point. USBLX is also a Balance fund using munis on the bond side.
  
  I believe these other tax managed funds mentioned are all equity funds.
• msf

  February 18

  Another allocation fund using munis is TAIFX. A fund of ETFs, including:
  
  CGHM 25% - Capital Group Muni High Income
  CGMU 21% - Capital Group Muni Income
  CGSM 3.5% - Capital Group Short Duration Muni Income
  
• bee

  February 18

  @msf,
  Where would I easily find "tax efficiency ratio" data for Funds? I recall it part of M*, but can't remember which tab. Thanks.
• PRESSmUP

  February 18

  @bee, I've considered the same topic and am leaning towards TAIFX, specifically due to its more global construction.
• WABAC

  February 18

  bee said:

  Thanks everyone. I appreciate all the responses.
  
  I recall USBLX using a similar tax managed strategy as VTMFX by investing in munis bonds. @msf or @observant1, do you know if the small cap funds, VTMSX or FSMD, are managed similarly?
  
  I would like to consider Non-US ETFs or mutual funds such as @WABAC suggested, but wonder if other taxes (foreign tax reporting) get triggered.

  IIRC those taxes can be deducted on the Federal tax.
• msf

  February 18

  bee said:

  @msf,
  Where would I easily find "tax efficiency ratio" data for Funds? I recall it part of M*, but can't remember which tab. Thanks.

  It's on the "price" tab, on the right side, next to other fees. (One might expect to find it under performance or perhaps under portfolio, but there it is, under price.)
  
• bee

  February 18 edited February 18

  @msf, Once again you are "Price-less"! Thanks.
  
  M* Tax Efficiency Methodology:

  The Morningstar Tax Cost Ratio measures how much a fund's annualized return is reduced by the taxes investors pay on distributions.
  
  Tax Cost Ratio Methodology
  
  Potential capital gain exposure (PCGE) is an estimate of the percent of a fund's assets that represent gains. PCGE measures how much the fund's assets have appreciated, and it can be an indicator of possible future capital gain distributions.
  
  Potential Capital Gains Exposure Methodology

  Tax Cost Ratio Methodology

  The tax cost ratio is a measure of how taxes reduce an investor’s return. It isolates
  the effects of taxes alone, and therefore can be used differently than after-tax
  returns, which reflect both tax effects and sales charges. Investors can use the tax
  cost ratio to evaluate if the portfolio manager is limiting taxable distributions to
  shareholders. It is a flexible tool that can help investors easily compare different time
  periods, different funds, and different categories. Investors pay taxes when they
  receive a taxable distribution and these costs are just as relevant as the expense ratio
  in reducing an investor’s take-home return.

  PotentialCapitalGainMethodology
  (A more interesting data point IMHO):

  PCGE estimates how much the fund’s assets have appreciated, and it measures the gains that have not
  yet been distributed to shareholders or taxed. It is especially relevant for investors who are considering a
  new purchase of a fund. If there are a lot of gains embedded in the fund, the investor may potentially
  receive capital gain distributions for gains that happened before they purchased the fund.
  A positive PCGE means that the fund’s holdings have generally increased in value. For example, if a fund
  started with $2,000, gained $500 and lost $100, the fund’s PCGE would be 17%, i.e. the net $400 gain
  divided by the total net assets of $2,400. The fund can either continue to hold the securities that
  appreciated or it can sell them. When a fund sells a security at a gain, it must distribute substantially all
  of those gains to shareholders that year. Investors then must pay taxes on those gains. So, a high PCGE
  can indicate the potential for upcoming capital gain distributions.
  A negative PCGE means that the fund has reported losses on its books. For example, if a fund started
  with $2,000, gained $100 and lost $500, the fund’s PCGE would be -25%, i.e. the net $400 loss divided by
  the total net assets of $1,600. The fund may be able to use those losses to offset future gains, thereby
  reducing the possibility of a capital gain distribution. Thus, investors should expect funds with negative
  capital gain exposure to be highly tax-efficient going forward.
  
  and,
  
  PCGE is helpful, because there are tax consequences for investors who buy a fund immediately before a
  distribution. For example, an investor buys one share of Fund A on December 15 at an NAV of $30.00,
  and then receives a capital gain distribution of $4.50 on December 16. Immediately after the distribution,
  the investor would have a share of the fund worth $25.50 and an additional $4.50 in cash. That cash,
  however, in the form of a capital gain, is taxable. Consequently, after paying 15% in capital gain taxes,
  the investor is left with $3.83 in cash.
• msf

  February 18

  IIRC those taxes can be deducted on the Federal tax
  
  If it's available (see below), one generally wants to take it as a dollar-for-dollar tax credit.
  
  Global mutual funds often don't pass through the foreign tax credit because they don't meet the 50% foreign holding requirement. 26 CFR § 1.853-1 Even if a global or foreign fund meets this requirement, it may elect not to pass through the credit.
  
  That's okay, because then the way it works is equivalent to getting a deduction on both your federal and state returns. For example:
  
  Suppose you would get $100 from a fund in gross divs before considering the $10 in foreign taxes the fund paid on your behalf. It might declare $100 in income on your 1099, give you credit for $10 in foreign taxes, and pay you $90 in real cash.
  
  Or, it might declare $90 in income on your 1099, end of story. That's equivalent to getting $100 declared and taking the $10 foreign tax as a deduction. Except that this works with state income tax as well as federal tax, since your 1099 income is just $90 for state as well as federal purposes.
• Mona

  February 18 edited February 18

  @bee,
  
  When evaluating a managed fund, I wouldn’t put too much weight on Morningstar’s 3-Year Tax Cost Ratio when deciding whether it's truly tax-efficient. A managed fund can look fairly tax-efficient for several years and then suddenly become much less so.
  
  https://www.morningstar.com/funds/xnas/vdigx/price
  
  VDIGX has lagged over the past three years, and in 2025 it experienced significant redemptions. To meet those withdrawals, the manager had to sell holdings, which triggered sizable capital gains distributions. As I recall, the fund distributed 13.64% of NAV. Not surprisingly, Morningstar’s 3-Year Tax Cost Ratio jumped to 2.43%.
  
  If you are seeking consistent tax efficiency year after year, an index fund is generally the better choice.
  
• yogibearbull

  February 18

  Heavy redemptions or manager changes can trigger large CG distributions, even to ETFs if they are classes of mutual funds.
• bee

  February 18 edited February 18

  @Mona,
  I agree. Vanguard to Pay More than $100M to taxable account holders of their Target Date Funds:

  The Vanguard Group, Inc. will pay $106.41 million to settle charges for misleading statements related to capital gains distributions and tax consequences for retail investors who held Vanguard Investor Target Retirement Funds (Investor TRFs) in taxable accounts.

  Vanguard to Pay More Than $100 Million to Resolve Violations Related to Target Date Retirement Funds
  
  Makes me wonder if owning a collection of individual stocks might be a consideration.

  ...if you’re looking for a more strategic approach that carries potentially significant tax savings, there’s a strong argument to be made for building an individual stock portfolio instead.
  
  With individual stocks, you’ll have far more control over when you realize gains and losses. That control can translate into meaningful tax savings over time, making individual stock portfolios a powerful wealth-building tool.

  source:
  case-building-individual-stock-portfolio-taxable-investment-account
• bee

  February 18

  Boglehead Link to Tax Efficient Fund Placement:
  
  bogleheads.org/wiki/Tax-efficient_fund_placement
• howaya

  February 18 edited February 18

  "Makes me wonder if owning a collection of individual stocks might be a consideration."
  
  source:
  case-building-individual-stock-portfolio-taxable-investment-account
  
  This is the conclusion I came to a decade ago. I am in a similar situation to @Mona, with mostly a taxable account and two of the four equity OEFs held therein for more than three decades. I was very uncomfortable buying individual stocks, at first. My first choice was a stodgy company with book a value of 0.7 at the time (COF). I still hold it now. Other positions are long held too, but the liquidated ones I let go only after at least a year to minimize taxes. TLH has also played a role. Individual stocks now represent easily more than 30% of my equity sleeve.
• Observant1

  February 18 edited February 18

  Direct indexing could be utilized in your tax management strategy.
  
  "Additionally, direct indexing can enable tax management.
  Given that you are purchasing individual stocks, it can be possible to tax-loss harvest each position
  to help manage your tax bill. By contrast, an ETf or mutual fund does not offer the ability to harvest
  individual positions. Typically, direct indexing is done in a taxable brokerage account for this reason,
  and not tax-advantaged accounts. Investors can either implement this strategy on their own or utilize
  a direct indexing opportunity that’s managed for them."
  
  https://www.fidelity.com/learning-center/trading-investing/direct-indexing
• Observant1

  February 18 edited February 18

  Coincidently, I just read today's Markets A.M. newsletter in which direct indexing is briefly discussed.
  
  https://trk.wsj.com/view/6965296053e1c001a9787e7bqb3qz.9qj7/21fa2aeb
• msf

  February 18

  it can be possible to tax-loss harvest each position to help manage your tax bill. By contrast, an ETf or mutual fund does not offer the ability to harvest individual positions.
  
  That's the sales pitch. The other side of the coin:
  
  With an ETF it can be possible to realize gains when the fund sells positions without immediately recognizing any cap gains for tax purposes. By contrast, an individual account does not offer the ability to sell off winners while deferring recognition of gain.
  
  It's a double edged sword. ETFs for the most part insulate you from the tax repercussions of trades within the portfolio. You can't harvest losses but you also can't defer the gains on liquidated holdings that have appreciated.
  
  Of course taxes come due with ETFs when you sell your ETF shares at a profit. But usually not when the ETF makes trades internally. The ETF sloughs off the recognition of gains onto authorized participants.
  
  Another pitch of direct indexing is that you can customize your index if there are some stocks you don't want to own. Economically, it doesn't make much sense to me but I can see it from a moral perspective.
• Observant1

  February 18 edited February 18

  "Another pitch of direct indexing is that you can customize your index if there are some stocks you don't
  want to own. Economically, it doesn't make much sense to me but I can see it from a moral perspective."
  
  Direct indexing can be used to reduce concentration risk in sectors or individual stocks.
  If an investor, for example, has a large position in Microsoft they can exclude MSFT
  and potentially additional stocks in the technology sector if needed.
• linter

  February 18

  i've held VTMFX has a long time but it's severely under performing these days (tho not as much as PRWCX, i don't think). would love to get rid of it but, again, the taxes. otoh, i'd be getting long term cap gains so maybe they won't be as bad as i fear.
• Observant1

  February 18 edited February 18

  Morningstar places VTMFX into the Moderately Conservative Allocation category.
  The fund's category returns for the trailing 3Y, 5Y, 10Y and 15Y periods are top-decile.
  VTMFX has exhibited above average risk in conjunction with high returns for 3Y, 5Y
  and 10Y according to Morningstar.¹
  
  "The strategy’s 10-year average equity allocation through March 2025 was 48%—13 percentage points
  greater than the average moderately conservative-allocation category peer’s exposure.
  Thus, the strategy is more volatile than 99% of peers,
  though strong absolute returns have more than compensated."
  
  
  
  ¹ Morningstar Risk is an assessment of the variations in a investment's monthly returns
  in comparison to similar investments. The greater the variation, the larger the risk score.
• fundly

  February 19

  These no or low leverage CEF's may be of interest to some. They are all tax managed from Eaton Vance.
  EVT,ETB,ETW,ETV. They have others in addition to the ones I mentioned. I own EVT and am waiting for a market decline to purchase the others.