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]
Additionally, looking at the overall trading fees, ETFs investors also enjoy low costs. For instance, some broad index-based ETFs can be traded commission-free. However, investors should note that different brokerage platforms offer varying commission-free ETF trades [Advisors Flock to Commission-Free ETFs]
Moreover, index ETFs come with some of the cheapest annual expenses around. The average expense ratio for a stock ETF is 0.59% and the cheapest comes in at 0.04%, according to XTF data.
While these characteristics help ETF investors save a little here and there, the savings add up over time, potentially bolstering overall returns by compounding over the years to come.
For more information on ETFs, visit our ETF 101 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.