In this second of a three part series, Kevin Ellman, CFP® explains why we should know about Exchange Traded Funds or ETFs.
Generally most index funds are very low cost, ranging between .08% and .70% where the average mutual fund expenses can range between 1.50% and 2.00%. In addition they can also be very tax efficient. To fulfill liquidation requests a mutual fund manager may have to sell assets that could generate a capital gain. This capital gain is then passed on to all existing shareholders who must pay taxes on these gains – even though they may not have sold any of the shares they own in their Portfolio. On the other hand, when you invest in ETF’s you will only pay taxes on capital gains that you may incur when you sell shares in your Portfolio at a profit.
Please keep in mind that you still may have to pay a commission charge to your broker for purchasing the ETF. They also lend themselves to effective tax management. Currently if you sell an asset at a loss and buy it back within 31 days. The IRS will not allow you to write the loss off as it violates the wash sale rule. With so many ETF’s available today, you could potentially sell an ETF, capture the loss and immediately buy another ETF that has a similar investment strategy. The replacement fund cannot be identical to the fund sold i.e.; you cannot buy a XYZ 500 Index Fund and replace it with an ABC 500 Index Fund. In addition ETF’s are fully transparent, meaning you can go online anytime 24/7/365 and see exactly which securities you own at that moment.