Tax-managed fund comparison

Vanguard offers five funds which are explicitly tax-managed. However, index funds and ETFs are inherently tax-efficient, and are sometimes less expensive; therefore, the tax-managed funds may not always be the best options even for taxable investors.

General Recommendations
Vanguard Tax-Managed International Fund (or the ETF equivalent Vanguard MSCI EAFE ETF) should save you in taxes at no extra cost. If you want to match the allocation of Total International, you can use 65% TM International, 20% Emerging Markets Index, and 15% FTSE All-World Ex-US Small-Cap ETF. However, the simplicity of Total International may be worth the small tax difference if you can make it your sole international holding.

Vanguard Tax-Managed Small-Cap Fund and Vanguard Tax-Managed Capital Appreciation Fund are worth holding if your taxable account needs a separate large-and-mid-cap or small-cap fund (and, in the case of TM Capital Appreciation, you don't mind its slight growth bias, say because you have a value bias in your IRA.) Except in the top tax bracket, TM Capital Appreciation is probably not worthwhile as a substitute for a large-cap-only fund; use 500 Index.

Total Stock Market is still better than a combination of tax-managed funds, except in the top tax bracket, and even then it is just as good.

Vanguard Tax-Managed Balanced Fund has no advantage over the individual funds other than simplicity, and may lead to extra tax costs.

Vanguard Tax-Managed Growth and Income Fund costs more in higher expenses than any tax savings.

Comparisons
Disclaimer: All of these calculations depend on assumptions about taxes and dividends, and may not represent the actual taxes or dividends of any fund. (Dividend yields are based on SEC yields as of April 19, 2013, except for international funds, for which they are estimates.) Consult your tax advisor for tax advice.

Calculations will be done with three tax assumptions: 15%/25%/top tax brackets. In the 15% tax bracket, qualified dividends and long-term gains are taxed at 0%. In the 25% tax bracket, qualified dividends and long-term gains are taxed at 15%. In the top tax bracket, investment income is taxed at 43.4% (including the 3.8% Affordable Care Act surcharge) and qualified dividends and long-term gains are taxed at 23.8% (including the surcharge). The total costs include the expense ratio of the fund.

All calculations assume Admiral or ETF shares of the alternative funds; given the $10,000 minimum for the tax-managed funds, you should have Admiral shares, and for multiple-fund combinations, the cost of waiting for Admiral shares is trivial. Expense ratios are adjusted for the acquired fund fees and expenses from Business Development Companies; the SEC requires these fees to be included in the reported ratio but they are misleading in a comparison of indexes.

Tax-Managed International
Vanguard does not quote SEC yields for its international funds; therefore, all yields in this section are estimates, based on a historical yield of about 2%. The exact yield does not affect the comparison; if the yield is 4% rather than 2%, all tax costs would be doubled.

Developed markets only
Developed Markets Index tracks the same index for 0.02% less. TM International may have an advantage in a lower dividend yield; we estimate 1.8% versus 2% (before foreign tax credit, assumed to be 7% of the dividends); we also include assumptions if both funds have the same yield except for expenses. TM International has 100% qualified dividends; Developed Markets are assumed to have 75%. Developed Markets Index has no ETF class and thus might distribute capital gains, but it isn't likely.

The negative tax cost in a 15% bracket is correct, as you pay no tax on qualified dividends and get a 7% credit. The credit on qualified dividends is lost if you have to file IRS Form 1116 to claim the credit and have very high foreign income, but this is not likely for investors in a 15% tax bracket.

Total international
To get the same allocation as Total International (which includes small-caps and emerging markets), you need 65% TM International, 20% Emerging Markets, 15% FTSE All-World Ex-US Small-Cap. The FTSE Small-Cap fund should be held as an ETF because it has no Admiral shares and the ETF is much less expensive; the others can be held as Admiral shares or ETF. The three-fund combination has 0.14% expenses, compared to 0.16% for Total International.

We assume a 2% yield for Total International with 70% qualified dividends, while TM International has a 1.8% yield with 100% qualified dividends versus 75%, and the other portions have a 2% yield which is 60% qualified; in the alternative assumption, we assume that combinations have the same yield before expenses. All funds are assumed to have 7% foreign tax credit. We also assume FTSE Small-Cap has 0.5% in long-term gains (0.08% of the portfolio); it distributed capital gains in 2009 and 2010 but not in 2011 and 2012.

You might also have your own capital gains rebalancing the three-fund combination, and it is definitely more complicated to manage, and more expensive to buy because the FTSE small-cap ETF trades at a relatively large spread. Thus, it doesn't have a clear advantage if you want to hold international stocks at the market weight. However, if you aren't holding the market weights (either as a deliberate decision to overweight small-caps or emerging markets, or because you have other international funds), so that you need a three-fund combination anyway, you might as well use TM International rather than Total International as the core holding, as you should save a few basis points in expenses and taxes.

Tax-Managed Small-Cap
TM Small-Cap tracks the same index as the S&P 600 ETF. Currently, TM Small-Cap has 0.02% lower expenses, but the S&P 600 ETF may reduce its expenses as it gets larger. The reported yields are almost equal, and neither fund is likely to distribute a capital gain. The advantage of TM Small-Cap is from its 100% qualified dividends, versus 75% assumed for the S&P 600, and the current lower cost.

If you do not use ETFs, Small-Cap Index has an expense ratio 0.03% less than TM Small-Cap, but a higher cap range, so you need more of Small-Cap Index to get the same small-cap exposure. In addition, it has a 0.29% higher yield, which causes dividends to cancel out the tax savings.

Tax-Managed Capital Appreciation
TM Capital Appreciation tracks the Russell 1000 index, with equal expenses to the ETF but a lower yield because it selects stocks to reduce dividend yields. Both funds should have 100% qualified dividends and avoid all capital gains; the tax-managed fund benefits from the lower yield.

Large-Cap Index is an alternative fund, and the alternative you would use if you do not use ETFs. It is a similar index with 0.02% lower expenses. 500 Index misses most of the mid-caps, but if you don't need mid-caps, it may be an even better deal than the tax-managed fund with a 0.07% lower expenses. These funds have slightly higher yields because large-cap stocks have higher yields than mid-cap stocks.

Tax-managed funds versus Total Stock Market
80% TM Capital Appreciation and 20% TM Small-Cap approximates the allocation of Total Stock Market. However, Total Stock Market saves 0.07% in expenses, also has 100% qualified dividends, should never distribute a capital gain, and eliminates your own potential capital gains from rebalancing the large-cap and small-cap funds. Total Stock Market thus comes out ahead of the TM combination except in the top tax bracket, and even there, you might lose the advantage of two basis points to capital gains from rebalancing.

Tax-Managed Balanced
TM Balanced is essentially the same as 49% TM Capital Appreciation and 51% Intermediate-Term Tax-Exempt. The expenses are equal, so the balanced fund has no advantage over the two separate funds other than simplicity. It isn't really suitable for a single-fund portfolio because it lacks international stocks. In addition, it has the usual disadvantage of a balanced fund in a taxable account: you cannot sell bonds without paying a capital gain on your stock sales.

Tax-Managed Growth and Income
TM Growth and Income has 0.12% expenses and tracks the same index as 500 Index, with 0.05% expenses. The tax management is trivial; the current yield difference of 0.06% is actually less than the expense difference, and 500 Index has 100% qualified dividends and has an ETF class to avoid its own capital gains.