There are two great advantages of ETF's that are hardly ever talked about these days. The first is
ETFs do much better (for reference, the average emerging market ETF paid out 0.01 percent of its NAV as capital gains over the same stretch).
Why? For starters, because they're index funds, most ETFs have very little turnover, and thus amass far fewer capital gains than an actively managed mutual fund would. But they're also more tax efficient than index mutual funds, thanks to the magic of how new ETF shares are created and redeemed.
their transparency and the second how efficient they are when it comes to tax time. Today we will compare ETF's to mutual funds in these two categories and show you why ETF's are light years ahead.
Transparency: One of the key benefits of ETFs is that they offer much better transparency in regards to their holdings than competing mutual funds. Given that investors' trust in Wall Street is at an all-time low, the ability to verify your positions on a daily basis is a big plus.
When a mutual fund investor asks for their money back, the mutual fund must sell securities to raise cash to meet that redemption. But when an individual investor wants to sell an ETF, he simply sells it to another investor like a stock. No muss, no fuss, no capital gains transaction for the ETF.
The system doesn't work so smoothly for all ETFs. Fixed-income ETFs, which have more turnover and often have cash-based creations and redemption's, are less tax efficient than their equity brethren.
Mutual Funds: See the problem with mutual funds is that they are only required to disclose their portfolios on a quarterly basis, and from that point only with a 30-day lag. In between reporting periods, investors have no idea if the mutual fund is invested according to its prospectus, or if the manager has taken on unwanted risks. Mutual funds can and do stray from their described targets this is known as "style drift") which can negatively impact an investor's asset allocation plan.
In short, when you buy a mutual fund, you're taking a leap of faith and in the past, investors have been burned.
But all else equal, ETFs win hands-down, with two decades of history showing they have the best tax efficiency of any fund structure in the business.
ETFs: Most ETFs disclose their full portfolios on public, free websites every single day of the year. iShares.com does a great job of posting the complete holdings of almost every ETF in the world. Otherwise you can simply google the ETF symbol and add "holdings" to the end and find the information that way.
Some ETFs, which are run by mutual fund companies such as Vanguard's products, will not report their ETF holdings. There is no law requiring that ETFs disclose their full portfolios every day.
Tax efficiency: If a mutual fund or ETF holds securities that have appreciated in value, and sells them for any reason, they will create a capital gain. These sales can result either from the fund selling securities for a tactical move, due to a rebalancing effort, or to meet redemptions from shareholders. By law, if funds accrue capital gains, they must pay them out to shareholders at the end of each year.
According to Barrons, the average emerging markets equity mutual funds paid out 6.46 percent of their net asset value (NAV) in capital gains to shareholders, every year.
ETFs do much better (for reference, the average emerging market ETF paid out 0.01 percent of its NAV as capital gains over the same stretch).
Why? For starters, because they're index funds, most ETFs have very little turnover, and thus amass far fewer capital gains than an actively managed mutual fund would. But they're also more tax efficient than index mutual funds, thanks to the magic of how new ETF shares are created and redeemed.
When a mutual fund investor asks for their money back, the mutual fund must sell securities to raise cash to meet that redemption. But when an individual investor wants to sell an ETF, he simply sells it to another investor like a stock. No muss, no fuss, no capital gains transaction for the ETF.
The system doesn't work so smoothly for all ETFs. Fixed-income ETFs, which have more turnover and often have cash-based creations and redemption's, are less tax efficient than their equity brethren.
But all else equal, ETFs win hands-down, with two decades of history showing they have the best tax efficiency of any fund structure in the business.
