Lazy portfolios can do more than just keep things simple — they can also help with taxes, especially in a regular taxable account. They are very tax efficient. Might not seem like much at first, but over time, those after-tax returns start to matter more than people think.
In a tax-deferred account — like an IRA or a 401(k) — taxes aren’t really an issue right away. You don’t need to worry much about capital gains or dividends each year. But in a taxable account, it’s a different game. How tax-efficient your setup is can make a real difference in how much wealth you actually get to keep.
So the question becomes — how do you build a lazy portfolio that’s smart about taxes?
We’ll look at a few things: which types of funds tend to be more tax-friendly, where to put each asset (depending on the account type), and how strategies like tax-loss harvesting can quietly boost returns in the background. Nothing complicated. Just a few small moves that can add up over the years.
Tax-Deferred Accounts vs. Taxable Accounts
In retirement accounts — like IRAs or 401(k)s — you don’t worry much about taxes year to year. They’re either deferred until you withdraw, or if it’s a Roth, not taxed at all. So tax efficiency takes a back seat. You can just focus on owning good stuff: low-cost, broadly diversified, and built to last.
But in taxable accounts? Whole different story as their dividends and capital gains are taxable. So here, how you invest and where you put certain assets starts to matter a lot more.
Key Factors for Tax Efficiency in Taxable Accounts
Stock Index Funds and ETFs Are Preferred
In taxable accounts, stock index funds and ETFs are generally more tax-efficient than actively managed mutual funds. This is because index funds and ETFs tend to have lower turnover, resulting in fewer capital gains distributions. Additionally:
- ETFs Are Preferred Over Mutual Funds: Stock ETFs often provide better tax efficiency due to their unique creation and redemption process, which minimizes taxable events. For example, Vanguard S&P 500 ETF (VOO) is typically more tax-efficient than its mutual fund counterpart, Vanguard 500 Index Fund Investor Shares (VFINX) . Furthermore, an index fund is a lot more tax efficient than an actively managed fund.
By prioritizing ETFs or index mutual funds, you can reduce the drag of taxes on your investment returns.
Fixed Income Investments: Municipal Bonds and Bond Fund Selection
For fixed income investments in taxable accounts, tax-exempt bond funds such as municipal bond funds can be advantageous for high-income investors. These funds generate interest that is exempt from federal taxes and sometimes state taxes, making them particularly appealing for those in higher tax brackets.
For a taxable bond fund investment, MyPlanIQ advocates for actively managed total return bond funds managed by reputable firms (e.g., PIMCO or Dodge & Cox) over bond index funds in certain scenarios. Actively managed bond funds may offer superior risk-adjusted returns, though this comes with slightly higher costs. The rationale behind this that the majority of taxable income for a bond fund comes from its interest income and thus both index bond funds and actively managed bond funds are not that much different in terms of tax efficiency. See Asset Classes And Fund Choices: A Primer for more detailed discussions.
As always, If unsure, defaulting to a low-cost bond index fund like Vanguard Total Bond Market ETF (BND) remains a solid choice.
3. Fund Placement Strategy Across Accounts
If you hold multiple taxable and tax-deferred accounts, strategic fund placement can further optimize your portfolio’s tax efficiency. This involves allocating assets based on their tax characteristics:
- Place Fixed Income in Tax-Deferred Accounts: Bonds and bond funds generate interest income, which is taxed as ordinary income at higher rates. To avoid frequent tax costs, allocate fixed income investments to tax-deferred accounts like IRAs or 401(k)s. For example, you could hold BND or an actively managed bond fund in your IRA while reserving stock ETFs for your taxable account. The rationale behind this is that, contrary to popular belief, index stock ETFs or mutual funds are a lot more tax efficient than bond funds that regularly generate interest income that’s usually taxed as ordinary income while index stock funds are buy and hold and generate very little taxable income if they are held in a long term.
- Utilize Tax-Loss Harvesting in Taxable Accounts: One powerful strategy for taxable accounts is tax-loss harvesting . This involves selling a losing position to realize a capital loss, which can offset gains elsewhere in your portfolio or reduce taxable income by up to $3,000 annually. After selling, replace the position with a similar fund to maintain your desired allocation. For instance:
- Sell VOO (S&P 500 ETF) at a loss.
- Replace it with VTI (Vanguard total stock market index ETF) temporarily.
- Revert back to your original fund after at least 30 days (preferrably much longer) to comply with the IRS “wash sale” rule.
Note, The IRS rule states that you need to switch to a substantially different investment to avoid triggering the wash sale rule. For example, switching from VOO to SPY would not avoid the wash sale rule, as both are essentially S&P 500 index funds and considered “substantially identical.”
This technique allows you to capture losses without disrupting your portfolio’s overall structure, enhancing your tax efficiency during volatile years.
Conclusion
Making a lazy portfolio more tax-efficient isn’t complicated, but it does take a bit of thought. It starts with how you choose the funds — and more importantly, where you put them.
In taxable accounts, broad stock index funds and ETFs tend to be the cleanest. Low turnover, low dividends, less friction. If you need bonds, municipal ones can help. Or sometimes even an active bond fund, depending on what your tax bracket looks like. But ideally, most of your fixed income sits inside a tax-deferred account — where it doesn’t throw off taxable income every year.
And then there’s tax-loss harvesting. It’s not exciting, but it works quietly in the background. Selling losers, booking the loss, then staying invested. Over time, that helps too.
The whole point here is simple: if you’re going to hold a lazy portfolio anyway, might as well make it a bit smarter from a tax perspective. Utilize the lazy portfolio tax strategies mentioned in the above!