Taxing Returns: 2025

Note: I realize there’s a lot happening in the markets right now—and yes, I’m still launching into a three-part series on after-tax returns. I do this every year because, no matter how noisy things get, focusing on what you can control (like taxes) is key to long-term investing success.

I’ll keep providing timely market updates, but staying disciplined is just as important now as ever. With that, let’s take a closer look at after-tax returns and how they fit into the bigger picture. -Jeff

Paying taxes is a good thing. Not only does it mean you’ve made money, but it’s also how we contribute to the projects that support the community and society in which we live.

You don’t have to take my word for it. In his most recent annual letter, Warren Buffett made this same point:

… Berkshire Hathaway – paid far more in corporate income tax than the U.S. government had ever received from any company – even the American tech titans that commanded market values in the trillions.

…as Charlie and I have always acknowledged, Berkshire would not have achieved its results in any locale except America whereas America would have been every bit the success it has been if Berkshire had never existed.

So thank you, Uncle Sam. Someday your nieces and nephews at Berkshire hope to send you even larger payments than we did in 2024.

Nonetheless, from an investment standpoint, taxes are a cost. While it’s generally good practice to try to keep your tax bill down, I think many investors go too far and confuse minimizing their tax bill with maximizing their after-tax returns.

Some investors obsess over taxes instead of their after-tax bottom line because taxes are easier to track (and painful to pay). We are handed a tax bill at least once a year—typically in April—but what about our after-tax mutual fund or ETF returns? Well, those are rarely displayed in black and white.

As I do every year, I’ll try to bring after-tax returns (and tax efficiency) out of the shadows. I’ll start by defining key terms and then provide a snapshot of Vanguard’s funds’ after-tax returns.

From that point, well, tax efficiency is a big topic, and there are several directions I could take the conversation.

Last year, I wrote a four-part series on exchange-traded funds (ETFs). The first two articles, ETFs 101 and 102, built up to a look at ETFs and their perceived tax advantages. The punchline is that Vanguard’s ETFs (which are index funds in a different wrapper) have no tax advantage over Vanguard’s index funds. I then examined the tax-friendliness of Vanguard’s actively-managed ETFs—here.

A year ago, I also showed you how municipal bonds provide a viable alternative to an asset location approach, which Vanguard advises investors consider.

ETFs and municipal bonds are valuable tools for tax-sensitive investors; I will revisit those topics at some point. But, for this year, I will let the articles I’ve already written stand. I encourage you to give them a read.

Instead, this year, I will turn my attention to the most common question I get about taxes: Should I own an active mutual fund in a taxable account?

With that said, let’s start at the beginning.

Which After-Tax Returns?

The mutual fund and ETF performance you see quoted pretty much everywhere—from Vanguard’s website to Morningstar to our Performance Review tables—are calculated without regard for taxes.

This is generally the “right way” to view fund returns. Not only do many investors hold funds in tax-deferred accounts, where taxes aren’t an issue, but each individual’s tax situation is unique.

That said, not all investments are held in tax-deferred accounts. And even if you’re not selling and creating a “taxable event,” mutual funds and ETFs make annual distributions on which you must pay taxes. Since those payouts are taxable, it’s worth considering how returns look after the IRS has taken its share.

There are two levels of after-tax returns to consider:

The first is your return after taxes on distributions. To calculate this return, you must apply a tax haircut to the dividend, interest and capital gain distributions paid out by a fund, even if you are reinvesting.

The second level is your return after taxes on distributions and the sale of the fund. This step involves accounting for the tax bill generated by the distributions and what you would owe if you sold your shares.

I see arguments on both sides of making this additional calculation. But to keep things simple—especially for long-term investors like us who don’t sell shares every year—I focus on the first measure: returns after taxes on distributions.

So, when I talk about after-tax returns, I’m adjusting for the taxes on a fund’s distributions, but I’m assuming you continue to hold your shares.

In the following analysis, I applied a 20% tax rate to qualified income (such as dividends) and long-term capital gains. I used a 43.4% tax rate for short-term capital gains and regular income such as interest. (For simplicity’s sake, I’ve omitted state and local taxes.) Finally, all of my calculations are as of March 31, 2025.

Once we have our before-tax and after-tax returns, we can calculate a fund’s tax efficiency—the percentage of a fund’s returns you keep after you’ve paid the tax man.

For example, Windsor II (VWNFX) earned a 10.3% annualized return over the 10 years ending in March. But after taxes, an investor took home just 8.5%, resulting in a tax efficiency of 82%. In other words, taxes ate up about one-fifth of the fund’s gross returns to taxes over the decade.

You might wonder why mutual funds and ETFs pay out distributions, saddling ongoing shareholders with a tax bill. In short, it’s the law.

Mutual funds and ETFs must distribute the interest and dividends they’ve received at least once a year. They must also pay all shareholders any net trading profits (capital gains). And remember, every fund—even index funds—engages in at least a little trading activity over the year.

While mutual funds and ETFs are on equal footing when it comes to dividends and interest, ETFs generally have an advantage regarding capital gains. However, as I explained last year, Vanguard’s index mutual funds and ETFs are simply different share classes of the same fund—so they receive identical tax treatment.

A Moment in Time

Now, let’s look at the tax-efficiency numbers for Vanguard’s funds and ETFs.

As I said, despite what some no-taxes-at-any-cost pundits will tell you, the goal of investing isn’t to avoid taxes but to maximize wealth after you’re done paying your taxes. Whether you like it or not, taxes are a reality. So, keeping an eye on the taxes you pay should be a factor in your investment strategy … but it’s not the whole story.

For your convenience, below is a downloadable PDF with the three-, five- and 10-year after-tax returns through the end of March 2025 for all of Vanguard’s stock, balanced and taxable bond funds. (Each period is sorted by after-tax returns.)

I’ve packed so much data into these tax efficiency tables that they can be hard to digest on the screen. If you’re looking to print out the tax efficiency tables, you’ll want to use the PDF.