Part 5: The Tax Edge: Unpacking ETF Tax Efficiency – Just in case you missed it here are the links to Part 1 our Pilot and Part 2 ETF V Mutual Fund and Part 3 Structures: NAV and Part 4 Liquidity
ETF’s at their core were originally mostly based on an index, think the S&P 500 aka the SPY by far one of the most popular. In part due to their core tracking of an index inherently ETF’s are more tax efficient. In addition to the index tracking, the creation of an ETF by the AP or Authorized Party also allows for certain tax advantage techniques. These occur when as mentioned in our prior Part 4 Liquidity discussion, the ETF needs to be expanded or contracted due to volume necessities.
Given the tracking of an Index, frequently capital gains are lower and income from the ETF can be predicted with some accuracy due to lower turnover generally in Indexes, overall making for possible more tax efficiency.
Since an ETF trades like a stock and can be traded throughout the day, an immediate sale of the ETF allows for quick control of taxes as well.
Pro-Tip – Behind the curtain of tax loss harvesting, as a regular process near the end of the year, a quick sale and repurchase of an ETF can realize gains and step up the bases in a portfolio, thereby offsetting possible losses and evening out tax ramifications within the taxpayers portfolio.
Overall, the original ETF which track, for the most part an Index of some type, was and is, generally more efficient than a regular Mutual Fund.
As we continue through this series we are going to note ETF’s have changed their form in many cases making for further scrutinization. More to come stay tuned!
John A. Kvale CFA, CFP
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Founder of J.K. Financial, Inc.
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