Investors interested in filling out their portfolio should consider diversified and tax-efficient exchange traded funds as an investment vehicle to help maximize potential returns and minimize costs.
When it comes to investing, taxes will be the largest factor that weighs on long-term investments. For instance, a stock investor may opt to hold onto their long-term stock positions and just cash in on dividends instead of selling their positions for fear of the capital gains tax hit, writes Mitch Tuchman for MarketWatch.
With ETFs, investors will enjoy more tax efficient benefits. For example, over the long-term, a stock ETF investor would reinvest dividends, and when an investor has to sell, one sells the most recently bought positions first.
In the event one needs to rebalance or acquire cash, the stock ETF invstor would start by selling the most recently purchased shares. Since you likely just acquired the position through dividend reinvestments, the shares have not appreciated as much and your capital gains hit is more negligible, compared to the first invested ETF shares.
Mutual fund investors will most likely see capital gains distributions as managers buy and sell positions throughout the year – each time a fund manager sells an appreciated position, the fund investor will be hit with taxes, which can add up over time. However, due to ETFs’ innate creation and redemption process, capital gains distributions are minimized or even negated – ETFs create and redeem shares “in-kind,” or swap a basket of underlying securities for ETF shares, which does not trigger a taxable event. [What an All-ETF Portfolio Does for You]