Taxes and the IVA Portfolios: Worth the Cost?

Lately, the same two questions keep landing in my inbox

Are the model portfolios meant to be used in a taxable brokerage account or only in tax-advantaged accounts?

And …

Do you have an ETF portfolio for all the different risk levels?

Boil it down, and both of these questions are really about the same thing: Taxes.

Here are the short answers:

Question 1: Both. Many readers follow the Portfolios in taxable accounts—but often with a few tax-related adjustments.

Question 2: No. I don’t offer ETF-only portfolios for every risk level.

To understand why, let’s get to the heart of these questions by answering a different question first: Where do your tax liabilities actually come from?

Two Sources of Tax Liabilities

Every portfolio generates a tax liability from two sources:

1. Income and capital gains that your holdings distribute
2. Gains (but not losses) that you realize when you trade

For Vanguard investors, the first category shows up as interest, dividends and capital gains paid out by its funds each year.

Those capital gain distributions, in particular, have become a source of tax pain for many investors, which helps explain the shift from mutual funds to ETFs.

But ETFs don’t eliminate your tax bill. While they give you more control over when gains are realized, ETFs still distribute income each year.

The second source—trading—is more personal.

I don’t trade the IVA Portfolios often, but when I do, investors in taxable accounts have to weigh the tax consequences of following my directives. In fact, taxes are one reason many readers continue to hold Dividend Growth (VDIGX) even though I recommended trading it for Dividend Appreciation Index (VDADX) last October.

Let’s put some numbers on each.

The Tax Cost of Using Active Funds

All stock funds generate a tax bill for their shareholders—even index funds and ETFs.