New research is displaying how index fund and exchange traded fund (ETF) investors can maximize their after-tax returns. Some tax experts believe that mutual funds shareholders’ tax bills will be the highest ever since 2000. In contrast, index funds and ETFs often have little or no taxable distributions. Eleanor Laise for The Wall Street Journal reports that investors holding these funds could slash their tax bill and boost their portfolios’ performance by taking an "asset location" approach, which refers to how investments are divided between taxable and tax-deferred accounts.

Here’s a tip on asset location: Keep tax-efficient investments such as index funds and ETFs in taxable accounts. If you must hold less tax-efficient holdings such as bond funds and commodities-based funds, put them in a tax-deferred account such as an individual retirement account or 401(k). While it’s important to take advantage of tax-deferred accounts, it’s also important to keep assets spread between taxable and tax-deferred accounts. You never know what tax rates will be 20 to 40 years from now. If you use more tax-efficient investments, such as ETFs, then there might be less to keep up with.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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