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Fund Spy: Morningstar Medalist Edition

6 Funds for Strong Aftertax Returns in the U.S.

Hint: Tax efficiency is not the right goal.

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If you are looking for a tax-efficient fund, you can just rank by tax efficiency and be done, right? No, in reality, tax efficiency isn’t all that helpful for a couple of reasons:

1) The goal is to maximize aftertax returns, not maximize tax efficiency (setting aside risk and goals, of course). There is a big difference between the two. You can put money in shoe boxes in your closet and have great tax efficiency. But what you really want is aftertax returns. If one fund has aftertax returns of 10% annualized the next 10 years and another has 8%, you want the one with 10%--regardless of whether you paid more taxes along the way. Vanguard is always eager to make this point because plain-old tax-efficiency measures actually penalize a lower-cost fund, as expenses are taken out of income; therefore, low-cost funds deliver higher aftertax returns but lower tax efficiency.

Russel Kinnel has a position in the following securities mentioned above: FTABX, VTCLX. Find out about Morningstar’s editorial policies.

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