Building a tax-efficient portfolio

Building a tax-efficient portfolio. Well again it’s going to be a top-down approach. Maybe the audience has heard this before. Bottom up which is security selection first, performance based, kind of piecing together something and at some point waking up and saying, how did I get here. That’s bottom up.

Top down is again determining your asset allocation through goals, through risk tolerance, through time horizon. Once you do that then you can start to work down. It’s almost like a Christmas tree. You start at the top, it’s asset allocation, then it’s sub-asset allocation, then different types of stock funds, international, domestic.

Index is a big part of that. And so back to the tax-efficient question. Indexing is a huge part. In fact, the bigger the client, sometimes the more questions I get, are you sure this index thing is the right thing? Shouldn’t we be doing something more complicated? And I say, you have more zeros and commas so you’re paying higher taxes, so we need to do this even more specifically. Trust me, we need to do this, and I show them the numbers and we build the portfolio. So indexing right out of the gate is a huge contributor to tax-efficient investing.

On the bond side, since we’ve been talking a lot about fixed income and interest rates, municipal bond strategies are very big for our clients. Most of the high-net-worth investors have an overweight towards retail accounts versus IRA accounts. So and there’s different kinds of strategies you can apply in bond investments, depending on where you’re doing that, whether it’s in an IRA or a taxable account.

So in taxable accounts where most of our clients live, it’s municipal bonds strategies. And that pays. I mean when I do the tax equivalent and yield for clients and they say okay that 2½% intermediate is all of a sudden 3½. That’s not too bad, it’s not great. But I’ll take that. And so what you end up getting then is tax-exempt income that’s at least federally tax-exempt and possibly partially depending on the state.

You have a very tax-efficient portfolio on the equity side that’s generated in the last few years, no capital gains from the fund, and if you didn’t sell it as a client, your accountant, your CPA is loving you and loving Vanguard. And you’re keeping all of that at the end of the day, it’s a beautiful thing.

source: Vanguard

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