Skip to main content

Tax-saving investments

Sometimes saving money on taxes is as easy as choosing the right types of investments.

POINTS TO KNOW

  • Investments that minimize trading activity and offset gains with losses will result in a lower tax bill.
  • Some investments are exempt from taxation altogether.

Index mutual funds & ETFs

Index funds—whether mutual funds or ETFs (exchange-traded funds)—are naturally tax-efficient for a couple of reasons:

  • Because index funds simply replicate the holdings of an index, they don't trade in and out of securities as often as an active fund would. Constant buying and selling by active fund managers tends to produce taxable gains—and in many cases, short-term gains that are taxed at a higher rate.
  • Since index funds have to buy new lots of securities in the index every time investors put money into the fund, the fund generally has hundreds or thousands of lots to choose from when selling a given security. This gives the fund manager flexibility to sell lots that have the lowest tax bite.
  • These funds will only sell their complete holdings of a specific security if the index itself removes the security, which is a good thing for investors, since such sales can result in large capital gains.

And because of the way they trade, ETFs may have an additional tax benefit.

When you sell shares of an ETF, you're selling to another buyer as opposed to the fund company. This means the fund itself usually isn't involved in the transaction and doesn't have to sell any securities, potentially triggering capital gains.

Learn more about:

Tax-managed stock funds

Some mutual funds are managed specifically to minimize the investors' tax burden, using strategies like:

  • Avoiding dividend-paying stocks.
  • Offsetting capital gains with losses.
  • Holding stocks for an extended period to avoid short-term gains.

Tax-managed funds are usually more expensive than comparable funds that don't have that additional layer of tax management. So they'll probably make sense for you only if you're in a higher tax bracket.*

Municipal bonds & bond funds

Income from municipal bonds, which are issued by state, city, and local governments, is generally free from federal taxes.** These bonds are often called "tax-exempt bonds." Municipal bond income is also usually free from state tax in the state where the bond was issued.

Because they offer this special tax treatment, these bonds generally give you lower interest rates than comparable taxable bonds. So like tax-managed funds, they make the most sense for investors in higher tax brackets.

You can use the tool below to "translate" a yield offered by a tax-exempt investment into a comparable taxable yield, which is known as the investment's "taxable-equivalent yield."

If comparable taxable bonds are currently offering a yield that's higher than the taxable equivalent, you'd be better off with the taxable investment.


Get complete portfolio management

We can help you custom-develop and implement your financial plan, giving you greater confidence—and potentially a lower tax bill.

Saving for retirement or college?

Take advantage of tax breaks just for you! See guidance that can help you make a plan, solidify your strategy, and choose your investments.

Already know what you want?

From mutual funds and ETFs to stocks and bonds, find all the investments you're looking for, all in one place.

REFERENCE CONTENT

Layer opened.

Index fund

A type of fund that seeks to track the performance of a particular market index by buying and holding all or a representative sample of the securities in the index, in the same proportions as their weightings in the index.

Layer opened.

Mutual fund

A type of investment that pools shareholder money and invests it in a variety of securities. Each investor owns shares of the fund and can buy or sell these shares at any time. Mutual funds are typically more diversified, low-cost, and convenient than investing in individual securities, and they're professionally managed.

Layer opened.

ETF (exchange-traded fund)

A type of investment with characteristics of both mutual funds and individual stocks. ETFs are professionally managed and typically diversified, like mutual funds, but they can be bought and sold at any point during the trading day using straightforward or sophisticated strategies.

Layer opened.

Index

An unmanaged group of securities whose overall performance is used as a benchmark. An index may be broad or focus on one sector or type of security.

Layer opened.

Capital gain

An increase in the value of an investment over the initial purchase price. A capital gain is "unrealized" until the investment is sold, when it becomes a realized gain. Realized gains are taxable and they may be considered short-term (if the investment was owned one year or less) or long-term (if the investment was owned for more than one year).

Layer opened.

Dividend

The distribution of the interest or income produced by a fund's holdings to its shareholders, or a payment of cash or stock from a company's earnings to each stockholder.

Layer opened.

Stock

Usually refers to common stock, which is an investment that represents part ownership in a corporation. Each share of stock is a proportional stake in the corporation's assets and profits.

Layer opened.

Yield

The income on an investment, expressed as a percentage of the investment's value.

Layer opened.

Lot

Shares acquired in one transaction. You can own multiple lots of an investment if you acquired shares of the same security at different times.

Layer opened.

Bond

A bond represents a loan made to a corporation or government in exchange for regular interest payments. The bond issuer agrees to pay back the loan by a specific date. Bonds can be traded on the secondary market.