ETFs and tax-efficiency (2024)

FAQs

Are ETFs really more tax-efficient? ›

ETFs are generally considered more tax-efficient than mutual funds, owing to the fact that they typically have fewer capital gains distributions. However, they still have tax implications you must consider, both when creating your portfolio as well as when timing the sale of an ETF you hold.

Thanks to the tax treatment of in-kind redemptions, ETFs typically record no gains at all. That means the tax hit from winning stock bets is postponed until the investor sells the ETF, a perk holders of mutual funds, hedge funds and individual brokerage accounts don't typically enjoy.

As a result, both ETFs have a very low expense ratio of 0.03% and a minimum investment of $1.00. Since VTI and VOO are both ETFs, they have the same trading and liquidity, tax efficiency, and tax-loss harvesting rules.

Consider investing in a tax-efficient REIT ETF: Some REIT etfs are more tax-efficient than others. For example, some ETFs have a lower turnover rate, which means they buy and sell assets less frequently, resulting in fewer taxable events.

Holding an ETF for longer than a year may get you a more favorable capital gains tax rate when you sell your investment.

Tax-loss harvesting can be a great strategy to lower tax exposure but traders must be sure to avoid wash sales. You can't replace a security that you've sold at a loss by purchasing one that's substantially identical from 30 days before the sale until 30 days after it's complete.

VOO typically provides a higher dividend yield compared to SPY. This aspect is particularly attractive to investors who prioritize income generation from their investments.

However, like fees on mutual fund, those paid on ETFs are indirectly tax deductible because they reduce the net income flowed through to ETF investors to report on their tax returns. Other non-deductible expenses include: Interest on money borrowed to invest in investments that can only earn capital gains.

Both have the same expense ratio and similar dividend yield, so you should choose whichever one you prefer based on the fund's strategy. If you only want to own the biggest and safest companies, choose VOO. If you want broader exposure and more diversification, choose VTI.

Do I pay taxes on ETFs if I don't sell? ›

At least once a year, funds must pass on any net gains they've realized. As a fund shareholder, you could be on the hook for taxes on gains even if you haven't sold any of your shares.

Average Return

Over the past 10 years, VOO has had annualized average returns of 12.67% , compared to 12.00% for VTI. These numbers are adjusted for stock splits and include dividends.

ETFs can be more tax efficient compared to traditional mutual funds. Generally, holding an ETF in a taxable account will generate less tax liabilities than if you held a similarly structured mutual fund in the same account. From the perspective of the IRS, the tax treatment of ETFs and mutual funds are the same.

An ETF gives you an affordable way to follow the stock market or a particular part of the market. While REITs provide the stability and robust returns of real estate.

ETFs have several advantages for investors considering this vehicle. The 4 most prominent advantages are trading flexibility, portfolio diversification and risk management, lower costs versus like mutual funds, and potential tax benefits.

ETFs expense ratios generally are lower than mutual funds, particularly when compared to actively managed mutual funds that invest a good deal in research to find the best investments.

ETFs, even in a good year, will underperform the best stocks in the fund, meaning investors could have owned just those stocks and done better. ETFs do charge an incremental cost, the expense ratio, for owning the fund.