By Solomon G. Teller, CFA, Chief Investment Strategist, Green Harvest Asset Management
Higher tax rates may accelerate the current transition of hundreds of billions of dollars migrating from mutual funds to ETFs. For high-income investors, in particular, recent research indicates that taxes may have even been the primary driver of this switch.1
As the Financial Times just highlighted, tax exposure is a growing risk for mutual fund investors, especially with the prospect of higher tax rates. Both mutual funds and ETFs must distribute gains when they sell a stock that has appreciated. However, unlike mutual funds, ETFs have a mechanism for reducing that gain to shareholders, as thought to have happened last week – see below-left chart. Moreover, given their structure, mutual funds face the risk of having to realize gains simply to raise cash in the event the investors choose to redeem their money. This dynamic may create the potential for a negative feedback loop – see below right chart.
Increasingly, higher income investors have been adopting ETFs as their tool of choice for portfolio construction and tax-beneficial investing. It will be interesting to see if that trend now accelerates. Visit our website or talk to your financial advisor to find out more.
1 Other potential advantages include lower transaction costs, less cash drag, transparency, intraday liquidity and lower expense ratios.
Performance quoted represents past performance, which is no guarantee of future results. Investment return and principal value will fluctuate, so you may have a gain or loss when the portfolio is liquidated. Current performance may be higher or lower than that quoted. Performance of an index is not illustrative of any particular investment. It is not possible to invest directly in an index.
GHAM does not provide tax advice. Although GHAM does not employ a Certified Public Accountant on its staff, we have, and continue to work with outside accounting firms and outside tax counsel that provide ongoing guidance and updates on all relevant tax law. Federal, state and local tax laws are subject to change. GHAM is not responsible for providing clients updates on any changes in tax laws, rules or statutes.
Reasons to harvest capital losses, sources of capital gains and the suggestion that mutual funds distribute capital gains are for example purposes only and not meant to be tax, estate planning or investment advice in any form or for any specific client.
All performance and estimates of strategy performance, after tax alpha, after tax alpha opportunities and other performance figures are derived from data provided from multiple third-party sources. All estimates were created with the benefit of hindsight and may not be achieved in a live account. The data received by GHAM is unaudited and its reliability and accuracy is not guaranteed.
The availability of tax alpha is highly dependent upon the initial date and time of investment as well as market direction and security volatility during the investment period. Tax loss harvesting outcomes may vary greatly for clients who invest on different days, weeks, months and all other time periods.
All estimates of past returns of broad, narrow, sector, country, regional or other indices do not include the impact of advisor fees, unless specifically indicated. Past performance and volatility figures should not be relied upon as an indicator of future performance or volatility.
This material is not intended to be relied upon as legal, investment or tax advice in any form or for any specific client. The information provided does not take into account the specific objectives, financial situation or particular needs of any specific person. All investments carry a certain degree of risk, and there is no assurance that an investment will perform as expected over any period of time.
As a convenience to our readers, this document may contain links to information created and maintained by third party sites. Please note that we do not endorse any linked sites or their content, and we are not responsible for the accuracy, timeliness or even the continued availability or existence of this outside information. While we endeavor to provide links only to those sites that are reputable and safe, we cannot be held responsible for the information, products or services obtained from such other sites and will not be liable for any damages arising from your access to such sites.