Better investing is more than just knowing about the market trends and the economics behind various sectors and countries. Savvy exchange traded fund (ETF) investors can also utilize tax rules to help maintain higher returns.

A typical tax strategy anyone can implement with ETFs is to to close out positions that have incurred losses before holding it for a year so that one may take advantage of short-term capital gains losses, comments Hans Wagner for Investopedia. Positions that have performed may then be held for more than a year, which would reduce tax liability since gains are taxed as long-term capital gains. [ETFs and Taxes: Understanding the Differences.]

Additionally, for those who are loath to exit a certain sector but who own a sector ETF that is faltering, one may consider selling the current ETF and buy a similar ETF that covers the same area, taking a loss on the original ETF for tax purposes.

The strategy is called tax-loss harvesting. To do it, you sell a losing position but buy an ETF that holds that same position, thereby avoiding losing your stake if things take a turn for the better. By utilizing this strategy, you maintain your exposure to an area of the market and picks up a capital loss for tax purposes. [Not All ETFs Are Taxed Alike.]

Although this strategy could be beneficial, a major drawback of it is the accumulation of transaction costs that go with buying and selling shares frequently. Secondly, you may find it hard to find good ETFs that enable you to successfully implement this strategy while maintaining the exposure to a desired asset class.

For more information on ETFs and taxes, visit our taxes category.

Max Chen contributed to this article.

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.

Subscribe to our free daily newsletters!
Please enter your email address to subscribe to ETF Trends' newsletters featuring latest news and educational events.