ETFs offer tax advantages to investors. As passively managed portfolios, ETFs (and index funds) tend to realize fewer capital gains than actively managed mutual funds. ETFs are more tax efficient than mutual funds because of the way they are created and redeemed. For example, suppose that an investor redeems $50,000 from a traditional Standard & Poor's 500 Index (S&P 500) fund. To pay that to the investor, the fund must sell $50,000 worth of stock. If appreciated stocks are sold to free up the cash for the investor, then the fund captures that capital gain, which is distributed to shareholders before year-end. As a result, shareholders pay the taxes for the turnover within the fund. If an ETF shareholder wishes to redeem $50,000, the ETF doesn't sell any stock in the portfolio. Instead it offers shareholders "in-kind redemptions," which limit the possibility of paying capital gains.

Related Reading:

Measuring Performance

Related Articles
  1. Investing

    Comparing ETFs Vs. Mutual Funds For Tax Efficiency

    Explore a comparison of mutual funds and exchange-traded funds, or ETFs, and learn what makes ETFs a significantly more tax-efficient investment.
  2. Investing

    An Inside Look At ETF Construction

    Everything you need to know about these versatile and ubiquitous investment vehicles.
  3. Financial Advisor

    5 Things All Financial Advisors Should Know About ETFs

    Discover five things all financial advisors should know about ETFs, including when ETFs may be a better choice for your clients than mutual funds.
  4. Investing

    4 Reasons Why ETFs Are Not Dangerous

    Discover four reasons why ETFs can be one of the safer investments on the market, including their transparency, low cost and tax-efficiency.
  5. Investing

    The Advantages of ETFs Compared to Index Funds

    With the ongoing ETF boom, ETFs gain more variety and increased competition in the market leads to further investors' advantages compared to index funds.
  6. Financial Advisor

    The Biggest ETF Risks

    ETFs have become so popular because of the many advantages they offer. Still, investors must keep in mind that they aren't without risks.
  7. Investing

    Want ETFs But Hate To Buy And Hold? Try Active ETFs

    Choosing between passive and active ETFs depends on your beliefs about active management's value.
  8. Taxes

    ETFs and Taxes: What Investors Need to Know

    It's true that ETFs can offer tax efficiency, but that's not always the case. Here's what investors need to watch out for.
Frequently Asked Questions
  1. What's the Best Way to Contact Warren Buffett?

    Learn how to contact Warren Buffett and what kinds of contact is most likely to receive a response from him or from his company, ...
  2. What is the Financial Services Sector?

    A diverse group of companies, beyond banks and credit unions, comprises the financial services sector.
  3. Who are Whole Foods' (WFM) main competitors?

    Whole Foods' main competitors are Sprouts Farmers Markets and Trader Joe's. However, the recent acquisition by Amazon my ...
  4. What caused the Stock Market Crash of 1929 that preceded the Great Depression?

    Find out what led to the stock market crash of 1929, which in turn led to the Great Depression. It sparked a nearly 90% loss ...
Trading Center