A further advantage to ETFs, at least to those of us in the US, is their tax advantage over a similar mutual fund. When a mutual fund changes it's holdings and creates capital gains, such as may happen when stocks get added or removed from an index, the holder of the mutual fund shares enjoy this taxable distribution by paying capital gains taxes to the IRS, even if those funds are then re-invested. Not so for an ETF which enjoys the ability to change it's portfolio without throwing off capital gains as a taxable event to the shareholder. You are only taxed on capital gains when you decide to sell shares, giving you better control over taxable income.

ETFs were not widely available when I first started investing, and my mutual funds from that time have done very well. So well that it would hurt to sell, from a tax POV, but the annual capital gains can trigger last minute gains of tens of thousands of dollars. Good problem to have, but it sure can complicate things like Roth Conversions and tax loss harvesting.

IP

Index Investing FAQ

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