3 ETF Retirement Bucket Portfolios for Taxable Accounts
These tax-efficient portfolios are geared toward retirees who are seeking simplicity and balance.
My original tax-efficient portfolios featured traditional mutual funds, not exchange-traded funds. And it's true that ETFs aren't the only game in town when it comes to limiting the drag of taxes on a taxable portfolio. Tax-managed funds, traditional index funds that track broad equity indexes, and old-fashioned municipal bond funds can all be tax-efficient, too.
But ETFs--especially equity ETFs--have some advantages that make them particularly good choices for investors concerned with tax efficiency. For one thing, the vast majority of ETF assets are in funds that track market indexes with very low turnover. Additionally, most ETF shares are traded in the secondary market among ETF buyers and sellers. Both of those features mean that that an ETF manager rarely, if ever, has to sell appreciated securities from the portfolio, unlocking taxable capital gains. In addition, for larger investors transacting in the primary market, ETFs' "in kind" creation and redemption mechanism, discussed here, helps further enhance tax efficiency.
Those last two features--the fact that ETF investors trade with one another and the creation/redemption mechanism--make ETFs an even better bet for taxable accounts than traditional equity index mutual funds, which are pretty tax-efficient themselves. Moreover, the advent of good-quality municipal-bond index ETFs makes it simple to assemble a well-diversified portfolio that consists exclusively of ETFs.
With maximum tax efficiency in mind, I've created three new tax-efficient all-ETF portfolios for retirees, as well as three "Retirement Saver" portfolios for people who are accumulating assets for retirement. These portfolios are meant to be used within the confines of investors' taxable accounts; for retirement accounts like IRAs and 401(k)s, there's no need to pay any attention to tax efficiency. As with all of the other portfolios, I used Morningstar's Lifetime Allocation Indexes to help shape the portfolio's basic asset allocations. I worked with Morningstar's passive strategies research team to populate the portfolios, relying on their lineup of Medalist-rated ETFs.
Customizing Your Buckets
Each of these in-retirement portfolios consists of three components: a cash bucket, a second bucket that holds high-quality muni bond funds, and a third bucket composed of equity ETFs. The Conservative portfolio has more in cash and bonds, whereas the Aggressive portfolio is heavy on equities. The Moderate portfolio falls in the middle.
As with all of my Bucket portfolios, I'd recommend that retirees use their own portfolio spending and personal situations (goals and risk tolerance/capacity) to determine how much they hold in each bucket. Many investors use their taxable accounts to store money to meet ongoing obligations or emergency expenses, so their liquid reserves in those accounts (Bucket 1) may be higher than is the case with their tax-sheltered accounts. In addition, many retirees are spending more aggressively from their taxable accounts than their tax-advantaged accounts, in keeping with tax-efficient withdrawal sequencing. As with the other retiree Bucket portfolios, the asset allocations shown here assume that the retiree will spend all of his or her assets, which may not be the case for those who would like to leave a bequest to loved ones or charity.
To use a simple example of how a retiree can use her own spending to determine the allocations to each bucket, let’s assume a retiree has a $200,000 taxable portfolio, from which she's spending $10,000 a year. She'd use that spending amount to arrive at how much to park in Bucket 1, and in turn Buckets 2 and 3. Using the Moderate version of the portfolios below, she'd hold six months' to two years' worth of portfolio spending in cash ($5,000-$20,000), another eight years' worth of expenditures ($80,000 in high-quality short- and intermediate-term municipal bond ETFs), and the remainder of the portfolio (half or nearly half of the assets, in this case) in stocks.
It's worth noting that these portfolios feature slightly higher equity positions than is the case with my other retiree Bucket portfolios, which I developed with tax-sheltered accounts in mind. That's because I avoided some of the higher-risk/higher-income fixed-income types that appeared in my other portfolios--for example, high-yield and emerging-markets bonds--because they're not very tax-efficient. Instead, I focused the portfolio's bond exposure on high-quality municipal bond funds.
In terms of portfolio holdings, the tax-efficient ETF portfolios keep things ultrasimple, largely because that's the best way to ensure tax efficiency. I employed total U.S. and international equity index funds to supply stock exposure and used short- and intermediate-term municipal bond ETFs for equity exposure. Note that U.S. total stock market index ETFs tend to be ultra-tax-efficient for the reasons outlined above. I used the Gold-rated Vanguard Total Stock Market (VTI) because its tax efficiency has historically been a touch better than iShares Core S&P Total US Stock Market (ITOT.) However, the Gold-rated iShares fund is currently a hair cheaper and the two funds are largely interchangeable. ( Schwab US Broad Market (SCHB) is also a good choice, but to date its tax efficiency hasn't been as impressive as the Vanguard and iShares funds.)
I also opted for a Vanguard total stock market index for international exposure, Vanguard Total International Stock (VXUS). But here again, iShares fields a worthy option in iShares Core MSCI Total International Stock (IXUS) and the two funds are fungible. The iShares fund has had better tax efficiency than the Vanguard fund over its five-plus-year history, but Morningstar analyst Dan Sotiroff expects that advantage would shrink if the iShares fund were to grow and the firm moved away from using sampling to replicate its underlying index and switched to full replication instead.
For fixed-income exposure for a taxable account, ETF investors now have several worthy municipal bond options from which to choose. The Silver-rated Vanguard Tax-Exempt Bond ETF (VTEB) serves as the portfolios' core fixed income position thanks to its very low costs and broad diversification. But as analyst Phillip Yoo points out in his analysis of the fund, it weights the bonds in the portfolio by market capitalization, which leads to some geographic concentration. (Not surprisingly, the portfolio has heavy weightings in New York and California munis.) For the short-term bond position, I used SPDR Nuveen Bloomberg Barclays Short-Term Municipal Bond (SHM). While not as cheap as Vanguard Limited-Term Tax-Exempt (VMLTX), an actively managed offering, the SPDR fund is one of the least expensive short-term muni ETFs.
For the cash piece--Bucket 1--an online savings account will tend to be the highest-yielding option, even on an aftertax basis. Investors in the highest tax brackets should consider a municipal money market fund; as yields are trending up, the tax haircut on cash will make a bigger difference than was the case in a lower-yielding environment.
Aggressive Tax-Efficient ETF Bucket Portfolio
Anticipated Time Horizon: 20-25 Years
Risk Tolerance/Capacity: High
Target Stock/Bond/Cash Mix: 60/30/10
10% SPDR Nuveen Bloomberg Barclays Short-Term Muni Bond ETF
20% Vanguard Tax-Exempt Bond
50% Vanguard Total Stock Market Index
10% Vanguard Total International Stock Market Index
Moderate Tax-Efficient Bucket Portfolio
Anticipated Time Horizon: 15-Plus Years
Risk Tolerance/Capacity: Average
Target Stock/Bond/Cash Mix: 50/40/10
15% SPDR Nuveen Bloomberg Barclays Short-Term Muni Bond ETF
25% Vanguard Tax-Exempt Bond
40% Vanguard Total Stock Market Index
10% Vanguard Total International Stock Market Index
Conservative Tax-Efficient Bucket Portfolio
Anticipated Time Horizon: 15 Years or Fewer
Risk Tolerance/Capacity: Low
Target Stock/Bond/Cash Mix: 35/55/10
20% SPDR Nuveen Bloomberg Barclays Short-Term Muni Bond ETF
35% Vanguard Tax-Exempt Bond
30% Vanguard Total Stock Market Index
5% Vanguard Total International Stock Market Index
Christine Benz does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.