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Exchange-traded funds (ETFs) have become increasingly popular since they were introduced in the United States in the mid-1990’s. Their tax efficiencies and relatively low investing costs have attracted investors who like the idea of combining the diversification of mutual funds with the trading flexibility of stocks. ETFs can fill a unique role in your portfolio, but you need to understand just how they work and the differences among the dizzying variety of ETFs now available.
Like a mutual fund, an exchange-traded fund pools the money of many investors and purchases a group of securities. Like index mutual funds, most ETFs are passively managed. Instead of having a portfolio manager, both index mutual funds and exchange-traded funds attempt to replicate the performance of a specific index.
However, a mutual fund is priced once a day, when the fund’s net asset value is calculated after the market closes. By contrast, an ETF is priced throughout the day and can be bought on margin or sold short – in other words, it’s traded just as a stock is.
Since their inception, most ETFs have invested in stocks or bonds, buying the shares represented in a particular index. For example, an ETF might track the Nasdaq 100, the S&P 500, or a bond index. Other ETFs invest in hard assets – for example, gold. With the rapid proliferation of ETFs in recent years, if there’s an index, there’s a good chance there’s an ETF that tracks it.
One of the reasons ETFs have gained ground with investors is because of their low annual expenses. Passive index investing means an ETF doesn’t require a portfolio manager or a research staff to select securities. Also, investing in an index means that trades are generally made only when the index itself changes. As a result, the trading costs are minimized.
ETFs can be relatively tax efficient. Because it trades so infrequently, an ETF typically distributes few capital gains during the year and they generally can minimize the ongoing capital gains taxes you’ll pay. This is why so many people enjoy using trading platforms similar to questrade canada because they can trade ETFs with great customer service, so some have mentioned.
Just how much impact can reducing taxes have over the long term? More than you might think. Even a one percent difference in your return can be significant. For example, if you invest $50,000 and earn an average annual return of five percent (compounded monthly), you would have a pretax amount of $82,350 after ten years. Even a one percent increase in that return would give you $90,970 at the end of that time. (This hypothetical example is for illustrative purposes only and does not represent the performance of any particular investment. Actual results will vary.)
Make sure you consider how an ETF’s returns will be taxed. Depending on how the fund is organized and what it invests in, returns could be taxed as short-term capital gains, ordinary income, or in the case of gold and silver ETFs, as collectibles; all are taxed at higher rates than long-term capital gains.
Your financial professional can help you decide how ETFs might fit your investing strategy.
About WealthTrust – Arizona
WealthTrust – Arizona is a fee based investment advisory firm that specializes in integrating portfolio management with estate planning for high net worth individuals and families. The professionals at WealthTrust – Arizona are frequently sought out by the national media such as The Wall Street Journal, Forbes, New York Times, CNBC, BloombergRadio and others to share their thoughts on matters that impact our clients.
Please call Paul Ahern at 480-483-7300 for an initial no-cost obligation meeting and start building your financial future with a Written Financial Plan.
Advisory services offered through WealthTrust-Arizona, a registered investment advisor. WealthTrust-Arizona does not engage in the trust business in the state of Arizona or in any other jurisdiction. Not FDIC insured. Not bank guaranteed. May lose value, including loss of principal. Not insured by any state or federal agency.