Tax-managed fund comparison - Bogleheads (2024)

This article contains details specific to United States (US) investors. It does not apply to non-US investors.

Vanguard offers three mutual funds which are explicitly tax-managed. However, index funds and exchange-traded funds (ETFs) are inherently tax-efficient, and are sometimes less expensive; therefore, the tax-managed mutual funds may not always be the best options even for taxable investors.

General recommendations

Vanguard Tax-Managed Small-Cap Fund is worth holding if your taxable account needs a separate small cap fund; it is less expensive than the corresponding ETF, and provides stronger small-cap exposure and almost no cost compared to Small-Cap Index. Vanguard Tax-Managed Capital Appreciation Fund is no longer worthwhile in most situations; it is about break-even in total cost in the top bracket, and could come out slightly ahead if your marginal tax rate is unusually high because of state taxes or phase-outs in the tax code. Likewise, Total Stock Market is better than a combination of the two tax-managed funds; it is about break-even in the top bracket and slightly ahead at an unusually high rate.

Vanguard Tax-Managed Balanced Fund has no tax advantage over the individual funds, just the simplicity; it has slightly lower expenses if your investment is less than $100,000. Even that benefit may be lost because of extra tax costs if you need to sell the fund to change your bond allocation.

Vanguard also used to have a Tax-Managed International Fund; it merged with the Developed Markets Index fund in 2014. If you previously had TM International, you should keep these shares rather than selling for a capital gain because the additional cost is trivial. The core of a taxable international portfolio could either be 80% Developed Markets and 20% Emerging Markets Index, or 100% Total International.

Comparisons

These comparisons are based on the total costs, including both taxes and expenses. Calculations will be done with three tax assumptions: 12%/24%/top tax brackets. In the 12% tax bracket, qualified dividends and long-term gains are taxed at 0%. In the 24% tax bracket, qualified dividends and long-term gains are taxed at 15%. In the top tax bracket, investment income is taxed at 40.8% (including the 3.8% Affordable Care Act surcharge) and qualified dividends and long-term gains are taxed at 23.8% (including the surcharge).

Your actual tax cost will be higher if you owe state taxes (add your state tax rate on the dividend yield, reduced by your federal tax rate if you itemize deductions and are not over the limit for deducting state taxes) or are in the phase-out range for some tax benefit such as the child tax credit (add 5% to all tax rates) or the personal exemption phase-out for the Alternative Minimum Tax (add 7% to all tax rates, but your overall tax on non-qualified dividends is 28% plus that 7%).

Tax-Managed Small-Cap

TM Small-Cap tracks the same index as the S&P 600 ETF, with 0.01% lower expenses, and a comparable yield. Neither fund is likely to distribute a capital gain. The advantage of TM Small-Cap is from more qualified dividends, but the difference has decreased since 2020, only 5-7% more than for the S&P 600 ETF and 2-3% more than Small-Cap Index. The table reports the 2018-2022 averages.

If you do not use ETFs, Small-Cap Index has an expense ratio 0.03% less than TM Small-Cap, and could give a slightly lower tax cost, but a higher cap range, so you need more of Small-Cap Index to get the same small-cap exposure.

Tax-Managed Capital Appreciation

TM Capital Appreciation tracks the Russell 1000 index, with 0.03% lower expenses than the ETF but a lower yield because it selects stocks to reduce dividend yields.

Large-Cap Index is an alternative fund, and the alternative you would use if you do not use ETFs. It is a similar index with 0.03% lower expenses. 500 Index misses most of the mid-caps, but if you don't need mid-caps, it is a comparable alternative. At a 23.8% marginal tax rate, the tax savings from TM Capital Appreciation do not cover the cost difference, but adding about another 10% in state tax and in phase-outs in federal tax would cause TM Capital Appreciation to have the lowest total cost.

All of these index funds should have close to 100% qualified dividends; the reported numbers are the 2018-2022 averages.

Tax-managed funds versus Total Stock Market

90% TM Capital Appreciation and 10% TM Small-Cap approximates the allocation of Total Stock Market. However, Total Stock Market saves 0.05% in expenses, has almost 100% qualified dividends, should never distribute a capital gain, and eliminates your own potential capital gains from rebalancing the large-cap and small-cap funds. Total Stock Market thus comes out ahead of the TM combination, even in the top bracket, unless your marginal tax rate on qualified dividends is well above 23.8%; it also avoids the need to realize your own capital gains if you rebalance between large-cap and small-cap funds.

Tax-Managed Balanced

TM Balanced is essentially the same as 49% TM Capital Appreciation and 51% Intermediate-Term Tax-Exempt. The expenses are 0.09% for both the balanced fund and the two individual funds (assuming Admiral shares of the municipal-bond fund with a $50,000 minimum; the expense difference is 0.05% if you have Investor shares). However, it isn't really suitable for a single-fund portfolio because it lacks international stocks. In addition, it has the usual disadvantage of a balanced fund in a taxable account: you cannot sell bonds without paying a capital gain on your stock sales. In particular, if you move to a high-tax state, you may want to sell your national municipal-bond fund and buy a fund for that state, but you will have to pay a capital-gains tax if your municipal bonds are in a balanced fund.

Total international

To get the same allocation as Total International, you need 80% Developed Markets (nee TM International), and 20% Emerging Markets. Developed Markets and Emerging Markets started to include small-caps in 2015, so there is no longer a need for the FTSE All-World Ex-US Small-Cap fund unless you want to overweight small-caps. The two-fund combination has 0.08% expenses, compared to 0.11% for Total International; both are 0.07% expenses for ETFs. If there is a cost advantage, you would not lose it to rebalancing costs, because Total International does not effectively rebalance to the 80/20 ratio; if emerging markets become 25% of the total international market, either Total International or an unrebalanced two-fund combination will be 25% emerging.

These funds are not a perfect match, as Emerging Markets Index includes China A-Shares, which causes it to have a larger weight in China than the emerging portion of Total International.

References