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About Stephanie Lo

Stephanie Lo has worked in finance and consulting, with a recent focus on tax-aware, unified managed household applied research and related technology. Stephanie has a PhD in economics from Harvard, with 500+ academic citations of her research, including a piece in the Journal of Finance. She can be reached at [email protected].

Exploring Bond Tax Efficiency: Futures or Bond ETFs?

Bond futures are often assumed to be more tax-efficient than bond ETFs. My analysis indicates that this assumption is frequently incorrect. Although investors might view the 60/40 tax treatment of futures as advantageous, a futures strategy faces several challenges compared to a bond ETF, including frequent taxable events, potential tax drag from cash collateral, and additional state taxation. My analysis suggests that, between July 2002 and July 2024, the bond ETF wins under a variety of realistic assumptions. However, bond futures may be compelling for high-tax investors, especially if they can find a tax-efficient cash solution. There is no universally “tax-efficient” instrument between bond futures and bond ETFs; rather, tax efficiency is defined by the investor’s particular circumstances.

Transitioning from an ETF to Direct Indexing? Bad Idea.

Many investors face the complex decision of whether to transition from a diversified ETF to direct indexing. When is this switch a poor investment choice? My findings suggest that many investors are better off avoiding it. Direct indexing remains attractive even with a decent amount of embedded capital gains, up to approximately 40% of initial investment, for investors in the highest marginal income tax bracket. However, for lower-tax investors with a marginal income tax rate of 22%, ETFs often prove more advantageous: when embedded capital gains exceed 10%, a consumption-focused investor is better off staying in an ETF. While the other benefits and costs of direct indexing are difficult to quantify, my results indicate that it is far from a universal solution. Investors with high embedded gains and lower tax rates should approach direct indexing cautiously.

About Stephanie Lo

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