Whenever a mutual fund sells a position at a gain, the taxable income is passed through to shareholders, even if distributions are then reinvested back into the fund. In contrast, ETFs limit these capital gains distributions through so-called in-kind swaps where securities are exchanged for ETF shares or vice versa, which do not trigger a taxable event. [Why Some ETFs Can Issue Capital Gains Distributions]
Moreover, more investors are beginning to realize that the higher fees associated with active mutual funds are weighing on overall returns. According to the Investment Company Institute, average fees on actively managed equity funds were 89 basis points in 2013, compared to 12 basis points for index equity funds.
The average investor may be better off with a passive index-based ETF.
“Index funds are a good long-term strategy for folks that don’t necessarily have an expertise in picking managers, or picking stocks themselves. That’s going to be the majority of us,” Stephen Horan, managing director at the CFA Institute, said in the article. “Are there active managers that have key insights and a steely discipline and an ability to capitalize and execute on those insights? I think the answer is yes. But they are not the norm.”
For more information on the fund industry, visit our mutual funds category.
Max Chen contributed to this article.