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Investing Specialists

3 ETF Retirement Saver Portfolios for Taxable Accounts

Composed of broad-market equity ETFs and smaller allocations to municipal bonds, these portfolios are designed for retirement savers' taxable accounts.

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This article is part of Morningstar's Guide to Passive Investing special report.

Stock market valuations aren't cheap, portending muted valuations from the asset class over the next decade. Bond yields have historically been a good predictor of what fixed-income assets will return over the next decade; while trending up, those yields are still pretty low. 

Low expected returns from the major asset classes accentuate the virtue of playing "small ball": maxing out contributions to tax-sheltered accounts, minding expense ratios, and working to reduce the drag of taxes for taxable holdings. 

With the last two goals in mind, I've developed tax-efficient exchange-traded portfolios--three geared toward retirement accumulators--outlined below—and three geared toward investors who are already retired

Exchange-traded funds aren't the only vehicles that are appropriate for investors' taxable accounts. In fact, the new tax-efficient ETF portfolios complement already-existing tax-efficient portfolios that consist of traditional mutual funds: mainly tax-managed funds, traditional index funds, and actively managed municipal bond funds. 

But ETFs, especially equity funds, lend themselves particularly well to taxable portfolios. For one thing, their turnover is low, and most ETF shares are traded in the secondary market among ETF buyers and sellers. Both of those factors keep an ETF manager from having to sell appreciated securities and unlock taxable capital gains. The creation and redemption mechanism for ETFs, discussed here, helps to further enhance ETFs' tax efficiency. Those tax benefits have been common knowledge since the first ETFs launched a couple of decades ago. But the advent of good-quality municipal-bond index ETFs--a relatively recent development--makes it simple to assemble a well-diversified, tax-friendly portfolio that consists exclusively of ETFs. 

These portfolios are designed for retirement assets held outside of the confines of IRAs and 401(k)s--in taxable, nonretirement accounts where investors pay taxes on each and every dividend and capital gains distribution their holdings kick off. As such, they're designed to keep those distributions--especially from capital gains--to a minimum. They also avoid taxable bonds, whose income is taxed at investors' ordinary income tax rates. As with all of the other model 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 ETFs.

Higher Equity Positions = Higher Return Potential, More Volatility
In contrast to my Bucket tax-efficient ETF portfolios geared toward retirees, these portfolios are geared toward people who are still accumulating assets for retirement. They have substantially higher equity positions than their in-retirement counterparts--ranging from 65% for the Conservative portfolio to 90% for the Aggressive--and don't hold anything in cash. Of course, from a practical standpoint, most of us hold are emergency-fund assets in taxable accounts. But because these portfolios are geared toward retirement accumulation, my assumption is that any emergency-fund needs would be held separate from the investments in these portfolios.

A Minimalist Mindset
As with my tax-efficient ETF Bucket portfolios, I maintained a minimalist mindset when putting together the tax-efficient ETF Retirement Saver portfolios. For investors who aren't super wealthy, their taxable accounts might not be large relative to their total retirement portfolios, so it's wise to keep things simple. In addition, most of the asset classes that retirement accumulators might look to for diversification--such as junk bonds or non-U.S. bonds--can jack up tax costs. There simply aren't that many asset types that are truly tax-efficient on an ongoing basis.

For the portfolios' equity positions, I employed total U.S. and international equity index funds to supply stock exposure, as such funds tend to be the most tax-efficient of any in the ETF world. I used the Gold-rated  Vanguard Total Stock Market (VTI) because of its low costs and record of good tax efficiency, but the Gold-rated  iShares Core S&P Total Stock Market (ITOT) is another fine choice. (Investors have another solid option in  Schwab US Broad Market (SCHB), but to date its tax efficiency hasn't been as good as the Vanguard and iShares funds.)

For international exposure, I also looked to total index ETFs. Both  Vanguard Total International Stock (VXUS) and  iShares Core MSCI Total International Stock (IXUS) are fine choices that are close to interchangeable. Ultimately, the decision largely boils down to investors' preferred brokerage platform: Investors who have access to commission-free ETF trades in Vanguard funds should use Vanguard, and those who can trade without commissions in iShares should use those funds instead.

For the core fixed-income exposure for retirement accumulators; taxable accounts, I employed the Silver-rated  Vanguard Tax-Exempt Bond (VTEB). It's the sole bond position in the Moderate and Aggressive portfolios, and one of two bond holdings in the Conservative portolio. 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.

Aggressive Tax-Efficient ETF Retirement Saver Portfolio
Time Horizon Until Retirement: 40 Years
Risk Tolerance/Capacity: High
Target Stock/Bond Mix: 90/10

10% Vanguard Tax-Exempt Bond 
65% Vanguard Total Stock Market Index 
25% Vanguard Total International Stock Market Index

Moderate Tax-Efficient ETF Retirement Saver Portfolio
Time Horizon Until Retirement: 20-Plus Years
Risk Tolerance/Capacity: Above Average
Target Stock/Bond Mix: 80/20

20% Vanguard Tax-Exempt Bond
55% Vanguard Total Stock Market Index
25% Vanguard Total International Stock Market Index

Conservative Tax-Efficient ETF Retirement Saver Portfolio
Time Horizon Until Retirement: 10 Years or Fewer
Risk Tolerance/Capacity: Low
Target Stock/Bond Mix: 65/35

20% Vanguard Tax-Exempt Bond
15% SPDR Nuveen Bloomberg Barclays Short-Term Muni Bond ETF 
50% Vanguard Total Stock Market Index
15% 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.