Mutual fund investors that got hit by the market pullback in 2018 will likely take another blow as many funds distribute capital gains. On the other hand, exchange traded funds will be able to highlight their tax efficient nature.

Mutual funds must distribute all their realized capital gains or profits on securities sold during the year. Mark Wilson of Mile Wealth Management and proprietor of CapGainsValet.com pointed out that as of the end of November, 517 funds announced they will pay at least 10% of net assets as taxable gains, and he projected that 531 funds will pay such large taxable distributions by year end, writes Jason Zweig for the Wall Street Journal.

Among the most widely held or largest active mutual funds on the market, the Fidelity ContraFund (FCNTX) showed a 7.2% capital gains distributions based off its most recent December long-term capital gain per share distribution and reinvestment price. Additionally, the Vanguard Wellington Fund Admiral Shares (VWENX) had a 6.4% distribution, The Growth Fund of America (AGTHX) had a 11.8% distribution, The Income Fund of America (AMECX) had a 7.5% distribution and Dodge & Cox Stock Fund (DODGX) had a 6.8% distribution.

In a year marked by volatility, investors have dumped active funds and turned to index-based funds. Active fund managers needed to sell off much of their portfolios to pay out the departing clients, and they are running out of holdings to sell at a loss to offset gains for tax purposes. Consequently, the liquidated positions can create a taxable gain, which is then dividend among the mutual fund investors whom are still sticking around.

On the other hand, ETFs are expected to distribute fewer meaningful capital gains this year, with only two ETFs from the largest fund sponsors expected to dish out cap-gains distributions of greater than 10% and most ETFs not expected to distribute any capital gains at all, writes Adam McCullough for Morningstar.

ETFs are typically viewed as a more tax efficient investment vehicle when compared to mutual funds because ETFs usually enact lower turnover strategies than actively managed funds, which diminishes realized capital gains and makes capital gains distributions less likely, and the ETF investment vehicle enjoys the structural benefits of so-called in-kind transactions where redemptions are conducted through tax-free transactions of ETF shares for a basket of underlying securities.

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