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Tax-Efficient Retirement-Bucket Portfolios for ETF Investors

These tax-efficient portfolios are geared toward retirees who are seeking simplicity and balance.

An illustrative image of Christine Benz, director of personal finance and retirement planning for Morningstar.
Securities In This Article
Vanguard Tax-Exempt Bond ETF
Vanguard Short-Term Tax-Exmpt Bd ETF
Vanguard Total Stock Market ETF
Vanguard Total International Stock ETF

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 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 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.

About the Portfolios

As with all of the other portfolios geared toward people in retirement, I used a bucket framework to guide how much to deploy into each asset type. The Bucket approach assumes that the investor holds cash-type assets to meet near-term spending needs in Bucket 1; intermediate-term assets like bonds and balanced-type funds in Bucket 2; and long-term investments, mainly stocks, in Bucket 3.

The Conservative portfolio has more in cash and bonds, whereas the Aggressive portfolio is heavy on equities. The Moderate portfolio falls in the middle. I used broad-market ETFs for equity exposure, and I focused the portfolios’ bond exposure on high-quality municipal bond funds.

To populate the portfolios, I worked with Morningstar’s passive strategies research team to identify low-cost ETFs that earn Morningstar Medalist ratings of Bronze or better. My aim is to make few changes to the portfolios on an ongoing basis; I’ll generally only make a change if an ETF is no longer a Medalist or if there’s a substantive change to the fund’s fundamental characteristics—for example, an expense-ratio hike.

How to Use Them

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. These portfolios, in contrast, are designed to limit income and capital gains distributions, and in turn investors’ tax bills.

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 per 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.

Aggressive Tax-Efficient Retirement-Bucket Portfolio for ETF Investors

Anticipated Time Horizon: 20-25 Years

Risk Tolerance/Capacity: High

Target Stock/Bond/Cash Mix: 60/32/8

Bucket 1

  • 8% Cash

Bucket 2

  • 10% Vanguard Short-Term Tax-Exempt Bond ETF VTES
  • 22% Vanguard Tax-Exempt Bond VTEB

Bucket 3

  • 40% Vanguard Total Stock Market ETF VTI
  • 20% Vanguard Total International Stock ETF VXUS

Moderate Tax-Efficient Retirement-Bucket Portfolio for ETF Investors

Anticipated Time Horizon: 15-Plus Years

Risk Tolerance/Capacity: Average

Target Stock/Bond/Cash Mix: 50/40/10

Bucket 1

  • 10% Cash

Bucket 2

  • 15% Vanguard Short-Term Tax-Exempt Bond ETF VTES
  • 25% Vanguard Tax-Exempt Bond

Bucket 3

  • 35% Vanguard Total Stock Market ETF
  • 15% Vanguard Total International Stock Market Index

Conservative Tax-Efficient Retirement-Bucket Portfolio for ETF Investors

Anticipated Time Horizon: 15 Years or Fewer

Risk Tolerance/Capacity: Low

Target Stock/Bond/Cash Mix: 40/48/12

Bucket 1

  • 12% Cash

Bucket 2

  • 20% Vanguard Short-Term Tax-Exempt Bond ETF
  • 28% Vanguard Tax-Exempt Bond

Bucket 3

  • 28% Vanguard Total Stock Market ETF
  • 12% Vanguard Total International Stock Market Index

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.

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About the Author

Christine Benz

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Christine Benz is director of personal finance and retirement planning for Morningstar, Inc. In that role, she focuses on retirement and portfolio planning for individual investors. She also co-hosts a podcast for Morningstar, The Long View, which features in-depth interviews with thought leaders in investing and personal finance.

Benz joined Morningstar in 1993. Before assuming her current role she served as a mutual fund analyst and headed up Morningstar’s team of fund researchers in the U.S. She also served as editor of Morningstar Mutual Funds and Morningstar FundInvestor.

She is a frequent public speaker and is widely quoted in the media, including The New York Times, The Wall Street Journal, Barron’s, CNBC, and PBS. In 2020, Barron’s named her to its inaugural list of the 100 most influential women in finance; she appeared on the 2021 list as well. In 2021, Barron’s named her as one of the 10 most influential women in wealth management.

She holds a bachelor’s degree in political science and Russian language from the University of Illinois at Urbana-Champaign.

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