ericd67 wrote:I'm not too concerned about the underlying transactions that take place such as in-kind exchanges etc, I just want to know how it affects ME. I assume I will pay a capital gains tax on $2 since I would be actually redeeming the share...so how is it more efficient?
It's more tax efficient because of what happens when people buy and sell the share.
For a naively managed mutual fund... when someone buy a share they go out and buy a tiny bit of everything. When you sell the share, they sell off a little bit of everything. This creates capital gains within the mutual fund itself that get distributed... and you thusly get taxed on.
With an ETF when someone buys or sells a share they're buying/selling an existing share directly with someone else. So there's no underlying buying/selling of assets going on to generate taxable capital gains distributions.
Now, that said, most large mutual funds have all sorts of strategies in place for managing this and it's generally not a problem. But this is where "ETFs are more tax efficient" comes from. Personally I prefer the simplicity of mutual funds and only have one asset class where I use an ETF because the asset class inherently has high transaction costs and thus the ETF is significantly cheaper as it can avoid many of the transactions that a mutual fund can't.