6 tax-saving strategies for smart investors

1. Consider tax‑efficient funds

There are many factors to consider when picking investments for your portfolio. When it comes to your nonretirement accounts, 2 such considerations are investment returns and tax efficiency.

You probably want to maximize after-tax returns for your portfolio. Choosing investments with built-in tax efficiencies, such as index funds—including certain mutual funds and ETFs (exchange-traded funds)—is one way you can minimize returns lost to taxes.

ETFs may offer an additional tax advantage. The way their transactions settle allows them to avoid triggering some capital gains.

Because ETFs offer the best of both worlds—low costs and tax efficiency—I often use them as a foundation for some clients' portfolios.

Note: Index mutual funds track a benchmark, so their goal is to match the benchmark's performance. If you're looking to outperform a benchmark, these investments may not be what you're looking for.

2. Weigh using actively managed funds focused on tax efficiency

Some clients I work with want an actively managed approach to their investments but don't want the tax burden that can come with that approach. When I build those clients' portfolios, I might choose funds from Vanguard's tax-managed investments. They offer active management with a focus on tax efficiency.* 

For clients in higher tax brackets, we may consider investing in tax-exempt bond funds, which pay lower interest rates but maximize after-tax returns.**

3. Divide assets among accounts

Picking tax‑efficient investments is one method to maximize after-tax returns, but you also want to choose the right types of accounts to hold your investments.

At the highest level, asset location is a way to minimize taxes by dividing your assets among taxable and nontaxable accounts. So you put investments that aren't tax‑efficient in accounts where you can defer taxes, and you hold tax‑efficient investments in taxable accounts.

When I work with my clients, I build tactics for tax‑efficient asset location into their custom financial plan, so they're able to keep more of their returns.

Taxable accounts should hold tax‑efficient assets like:

• Index mutual funds.
• Index ETFs.
• Tax-exempt bonds.
• Stocks.

Nontaxable accounts should hold less tax‑efficient assets like:

• Actively managed mutual funds.
• Taxable bonds.

4. Look for opportunities to offset gains

As an investor, you're only taxed on net capital gains—the amount you gained minus any investment losses—so any realized losses can help lower your tax bill. Therefore, if you know you're going to have realized gains, it may make sense to look for opportunities to realize losses to offset them.

For example, if you have shares of funds or stocks that have lost value since you purchased them, you may want to consider selling them. 

This intentional selling of investments at a loss to lower taxes is known as tax-loss harvesting.†

If you have a year when your capital losses are greater than your capital gains, you can use up to $3,000 of net losses a year to offset ordinary income on your federal income taxes. You can also "carry forward" losses to future tax years. As with any tax-related topic, tax-loss harvesting has rules and restrictions (such as the wash sale rule) that you should be aware of before using this method.