Most Tax-Efficient Investments: 4 Options to Consider
What are the most tax-efficient investments?
The most tax-efficient investments depend on where you hold them, how they generate returns, and when you need the money. For a taxable brokerage account, investments that produce little taxable income each year are often a strong starting point. Tax-advantaged accounts can make a bigger difference for investments that regularly pay taxable interest or distribute gains.
Broad-market index funds and ETFs
Low-turnover index funds and many exchange-traded funds (ETFs) can be tax-efficient choices in a taxable account. Because they generally trade less often than actively managed funds, they may distribute fewer capital gains. You still owe tax when you sell shares at a gain, and dividends may be taxable along the way. Compare a fund’s strategy, costs, and distribution history rather than assuming every ETF has the same tax profile.
Municipal bonds
Interest from many municipal bonds is exempt from federal income tax, making them worth considering if you’re in a higher tax bracket and want bond income in a taxable account. Some bonds may also offer state or local tax benefits. Compare the bond’s after-tax yield with a taxable alternative: a tax break does not automatically make it the better investment. Certain municipal-bond income may still be subject to state tax or the alternative minimum tax.
Treasury securities
Interest from U.S. Treasury bills, notes, and bonds is subject to federal income tax but generally exempt from state and local income taxes. That can make Treasuries attractive if you live in a state with income tax. Choose a maturity that fits when you’ll need the money, since selling a Treasury before maturity can result in a loss.
Tax-advantaged accounts
A 401(k), traditional IRA, or Roth IRA can reduce tax drag, though each works differently. Traditional accounts generally defer tax on eligible contributions or investment growth until withdrawal; Roth accounts may allow tax-free qualified withdrawals. Contribution limits, eligibility rules, and withdrawal requirements matter. These accounts can be useful places for investments that generate frequent taxable income, such as many bond funds.
Our team’s practical approach is to choose an investment for your goals and risk tolerance first, then consider its tax treatment and account location. Taxes are only one part of your return. For a fuller framework, explore our guide to tax-efficient investing.
FAQ
Where should you hold tax-inefficient investments?
Tax-advantaged accounts are often a useful home for investments that regularly produce taxable interest or capital-gain distributions. Your best placement also depends on your account options, withdrawal plans, and tax situation.
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