ETF Tax Efficiency

June 9, 2021

While ETFs and mutual funds are similar in some ways, they are also very different. ETFs potentially provide much more transparency, flexibility, tradability and tax efficiency. There’s never been a better time to explore the many potential benefits and tax advantages of an ETF.

“What makes an ETF more tax efficient than a mutual fund?” This question may be more important right now than ever.

Both investment vehicles are designed to provide exposure to a basket of securities, but important distinctions allow an ETF to provide more favorable tax outcomes.

 

One possible reason for this is the “in kind” creation and redemption mechanism that is unique to ETFs. Securities and ETF shares are exchanged between the authorized participant and the ETF issuer “in kind”, meaning no transactions occur within the portfolio, leading to less opportunity for capital gains.

Additionally, with mutual funds, capital gains can occur even as part of a portfolio manager’s daily trades or a shareholder redeeming shares. The mutual fund provider might have to sell underlying securities to raise cash, and that potential gain is distributed among shareholders.

 

Particularly in today’s legislative climate, advisors and investors are considering tax efficiency as a key benefit in the shift from mutual funds to ETFs. While ETFs and mutual funds are similar in some ways, they are also very different. ETFs potentially provide much more transparency, flexibility, tradability and tax efficiency. There’s never been a better time to explore the many potential benefits and tax advantages of an ETF.

 

Visit WisdomTree.com to learn more about ETFs and their numerous benefits.