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ETFs are inherently more tax efficient due to how the investments are structured.
Investors may be able to save some money by understanding how ETFs and mutual funds are taxed.
Heres everything you oughta know about ETF vs. mutual fund tax efficiency.
Mutual funds are typically managed by a fund manager who selects investments based on thestated fund goal.
Mutual funds may be less tax efficient because of how they are managed.
Active funds, for example, may trade a lot and realize more capital gains.
Exchange-traded fundsare very similar to mutual funds in that ETFs hold multiple securities within a single fund.
Unlike mutual funds, ETFs can be actively traded during market hours and are treated more like stocks.
Most ETFs offer hands-off management by just tracking a market index which keeps capital gains and taxable events lower.
Heres how ETFs and mutual funds compare in each of these categories.
If youve held the investment for less than one year, any gains are considered ordinary income.
This can make mutual funds much less tax efficient than investing with ETFs.
Dividends are paid by companies from excess profits to shareholders.
Dividends can also be paid out by bonds, REITs and other types of investments.
Dividends are taxed at your ordinary income tax rate.
As for costs, mutual funds that are actively managed typically have much higher expense ratios than ETFs.
ETFs are typically much more cost efficient than mutual funds due to their passive managed nature.
This can save investors money and increaseoverall fund performance.
However, active mutual funds may outperform ETFs in specific market conditions or sectors, depending on their strategy.
ETFs are usually passively managed, and according to Morningstar, passive index funds typically outperform actively managed funds.
Since many mutual funds are actively managed, passive index fund ETFs may outperform comparableactive mutual funds.
It really depends on the underlying investments, fund fees, asset class, investing timelines and other factors.
But the difference depends on how much you have invested and the throw in of fund chosen.
Mutual funds have been around much longer, and there are far more choices for investing strategies.
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