Tax-Efficient Model Portfolios

You won’t earn any tax breaks when investing in a taxable (nonretirement) account: no deduction on your contributions, no tax-deferred compounding, no tax-free withdrawals.

So why bother? Maximum flexibility. In contrast with a tax-sheltered retirement account, you can put as much into a taxable account as you can save. You’re able to pull the money out whenever you need it without penalty, and you can invest in anything you like. If you’re a supersaver, a taxable account may be the only option left once you’ve maxed out your tax-sheltered retirement savings vehicles.

And if you’re careful with investment selection, your taxable account can be nearly as tax-efficient as your retirement accounts. For equity exposure, exchange-traded funds, index-tracking mutual funds, and tax-managed funds have all managed to limit the tax collector’s cut of annual returns. Limiting taxes on bonds and cash investments is a bit trickier, in that their income payouts are dunned at your ordinary income tax rate. But for investors in high tax brackets, municipal bonds can be a solid choice because their income distributions skirt federal and in some cases state and local taxes, too. It’s always wise to factor in your own tax rate to determine the appropriateness of municipal versus taxable bonds. Investors in lower tax brackets may be better off with taxable bonds, even on an aftertax basis, than they will with munis.

I’ve developed several tax-efficient model portfolios that you can use as you set your own taxable portfolio’s allocations and holdings. These portfolios consist of Morningstar Medalist mutual funds and exchange-trade funds. Note that they’re all geared toward retirement: The first set of portfolios below are intended for retirees who are actively drawing upon their accounts for spending money and the other half are for retirement savers. If you’re investing for a goal other than retirement—one that’s closer in proximity and shorter in duration—my taxable portfolios for short- and intermediate-term goals may be useful.

Tax-Efficient Portfolios for Retirees

These in-retirement portfolios all use a three-bucket approach: a liquidity bucket for one to two years’ worth of portfolio spending, an intermediate-term bucket consisting of high-quality municipal-bond funds for another five to eight years’ worth of portfolio withdrawals, and the remainder in a globally diversified equity bucket.

Each of the series below includes an Aggressive, Moderate, and Conservative version. The Aggressive versions are geared toward younger retirees who are tapping their portfolios at a rate of roughly 4% per year. The Conservative versions are meant for older retirees with an approximately 10-year time horizon (remaining life expectancy) and a higher spending rate of roughly 6% per year; thus, they’re heavier on cash and bonds. The Moderate portfolios fall between the two and use a 5% assumed spending rate.

Note that it’s possibly to customize a Bucket portfolio based on your own portfolio spending; simply use your annual withdrawal percentage as the yardstick to determine how much to drop into each bucket. (And be sure to check to be sure that your portfolio withdrawal is sustainable!)

For retirees who are in drawdown mode, tax considerations may influence higher withdrawals from their taxable holdings than from their portfolios in aggregate and, in turn, more conservative positioning of the taxable portfolio. There are no one-size-fits-all rules for tax-efficient portfolio sequencing, but taxable holdings often go in the “spend first” column. Even though taxable accounts can be invested to reduce the tax drag, they don’t offer the structural tax deferral that traditional tax-deferred or Roth accounts do.

The first two series are the “core” portfolios. The fund-family-specific portfolios are geared toward investors who would prefer to consolidate their investments with a single firm. The Minimalist portfolios are ultra-streamlined.

Tax-Efficient Retirement Bucket Portfolios (Mutual Funds)

Tax-Efficient Retirement Bucket Portfolios (ETFs)

Tax-Efficient Retirement Bucket Portfolios (Vanguard)

Tax-Efficient Retirement Bucket Portfolios (Fidelity)

Tax-Efficient Retirement Bucket Portfolios (T. Rowe Price)

Tax-Efficient Retirement Bucket Portfolios (Schwab Supermarket)

Tax-Efficient Retirement Bucket Portfolios (Minimalists)

Tax-Efficient Portfolios for Retirement Savers

A Bucket system isn’t necessary for the preretirement years because active portfolio spending hasn’t yet commenced. But time-horizon considerations should be a key aspect of portfolio planning for savers, too. Each of the below series has three portfolios: Aggressive for people who are early in their careers; Moderate for midcareer accumulators; and Conservative for people who are within 10 or so years of retirement. Morningstar’s Lifetime Allocation Indexes help shape their basic asset allocations.

As with the Bucket portfolios, tax-efficient equity funds—mainly index funds and ETFs—provide stock exposure to these portfolios. Meanwhile, the fixed-income allocation consists of municipal-bond funds in all the portfolios. For some investors, however, taxable bonds will deliver a higher aftertax yield than munis.

For accumulators in search of tax efficiency, a hands-off, buy-and-hold approach is usually the best way to limit taxable capital gains realization. Not only do you want your holdings themselves to be tax-efficient, but you need to be tax-efficient, too! That’s usually best achieved by not making many changes. However, there may be times when tax-loss harvesting opportunities beckon; 2022 was one such recent example. The specific share identification method for tracking cost basis will tend to give retirement savers the most discretion over their gain and loss realization.

The first two series are the “core” portfolios. The fund-family-specific portfolios are geared toward investors who would prefer to consolidate their investments with a single firm. The Minimalist portfolios are ultra-streamlined.

Tax-Efficient Retirement Saver Portfolios (Mutual Funds)

Tax-Efficient Retirement Saver Portfolios (ETFs)

Tax-Efficient Retirement Saver Portfolios (Vanguard)

Tax-Efficient Retirement Saver Portfolios (Fidelity)

Tax-Efficient Retirement Saver Portfolios (T. Rowe Price)

Tax-Efficient Retirement Saver Portfolios (Schwab Supermarket)

Tax-Efficient Retirement Saver Portfolios (Minimalists)