ETF more tax friendly than mutual funds?

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ETF more tax friendly than mutual funds?

Postby bogleblitz » Sat Feb 09, 2013 2:26 am

I found this article pretty boglehead friendly:
http://dailycapital.personalcapital.com ... stor-sins/

I don't understand point #4: Poor Tax Management
Quote
"Relative to mutual funds, Exchange traded funds (ETFs) are a step in the right direction. In fact, greater tax efficiency was the primary reason they were created. But the best way to mitigate taxes is to create a portfolio of individual securities, or a combination of individual securities and ETFs. This allows for tax management on multiple levels. With a wider set of options to meet cash flow needs, it’s easier to defer gains into future years. And if you have to sell low basis positions, you can harvest losses from poor performers to mitigate or neutralize the impact."

So does that mean I should buy VTI instead of VTSMX? Or the above only applies to active mutual funds and index funds are pretty tax efficient.

Currently I own all index mutual funds in 401k, roth, and taxable.
Thanks in advance
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Re: ETF more tax friendly than mutual funds?

Postby Jack » Sat Feb 09, 2013 3:24 am

VTI and VTSMX have exactly the same tax efficiency because they are simply different share classes of the exact same mutual fund. The only difference is expense ratios, but not tax efficiency. The mutual fund gets a free ride on the tax advantages of the ETF. Vanguard has a patent on combining ETFs and regular mutual funds.
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Re: ETF more tax friendly than mutual funds?

Postby BrandonBogle » Sat Feb 09, 2013 4:12 am

Op, what you read us true for most, if not all, NON-Vanguard MF vs ETFs. As Jack was alluding to, Vanguard mutual funds get the benefit of this because rather than have two separate entities and separate sets of holdings, Invesor, Admiral, ETF, Signal, Institutional, etc. are different share classes of the same overall fund. You don't see that outside Vanguard.

Basically, an ETF is more tax efficient because if you sell 10k of shares, the underlying assets do NOT need to be sold to meet your redemption. Instead, your shares of the ETF are sold to whoever is buying 10k of the same ETF. That way, the fund need not turn over any assets. If there is an imbalance of the overall underlying fund, the ETF can swap out the an equivalent amount amongst all it's holdings to an institution making a market for a holding and they provide the cash instead.

Now, with Vanguard MFs and ETFs, since they are all part of the same fund, redemptions in the MF can be passed through the ETF. Thus, all Vanguard MFs are as tax-efficient as their ETF counterparts. Other companies can't simple pass MF activity through the ETF.
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Re: ETF more tax friendly than mutual funds?

Postby skibbi9 » Sun Feb 10, 2013 5:01 pm

I thought the ETF vehicle is able to shelter more of the dividends.. but can't remember the details/
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Re: ETF more tax friendly than mutual funds?

Postby grabiner » Sun Feb 10, 2013 5:27 pm

skibbi9 wrote:I thought the ETF vehicle is able to shelter more of the dividends.. but can't remember the details/


There is no way to avoid taxation on dividends (except by paying them to the fund manager as higher expenses rather than to the shareholders as cash, which doesn't help shareholders). ETFs, and Vanguard funds with an ETF share class, can reduce the capital gain distributions.
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Re: ETF more tax friendly than mutual funds?

Postby cheese_breath » Sun Feb 10, 2013 5:28 pm

skibbi9 wrote:I thought the ETF vehicle is able to shelter more of the dividends.. but can't remember the details/

Depends. With Vanguard VTI and VTSMX are just different classes of the same product and have the same tax advantages. Other companies may offer their mutual funds and ETFs as different products, and the ETFs may have some tax advantages.
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