Exchange-traded funds have a 'tax magic' that many mutual funds don't offer
Published On Dec 30, 2024, 2:30 PM
Exchange-traded funds (ETFs) provide significant tax advantages compared to mutual funds, particularly in terms of capital gains taxes. Due to their unique structure, fewer ETF investors incur annual tax bills from capital gains distributions. In 2023, over 60% of stock mutual funds distributed capital gains, while only 4% of ETFs did. This difference is primarily due to ETFs using 'in-kind' transactions, which allow for tax-free trades and generally lower capital gain distributions. These benefits are particularly impactful for investors holding assets in taxable accounts, as the tax efficiency can lead to better overall returns than traditional mutual funds.
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With the increasing awareness of the tax advantages of ETFs over mutual funds, investors may shift their focus and capital towards ETFs, particularly within taxable accounts. This could lead to increasing demand and pricing for ETFs.
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