ETFs vs Index Funds in taxable account

[Sodak]

I currently own index funds in a Roth IRA and 401k. I’m going to put some money into a taxable account. I am far from an expert but have heard ETFs are the way to go in a taxable account over mutual funds. What exactly are the tax advantages of etfs? Can I trade one etf for another without it being a taxable event? Thanks for the help and info.

[Makefile]

If you invest at Vanguard, and buy the major Vanguard funds that also have an ETF share class (i.e., the "total" ones), there is no tax efficiency difference.

Other index mutual funds may make capital gain distributions, which may raise your taxes. Depending on the size of the fund, fund manager, and behavior of its shareholder base, the fund may be able to avoid making these, or may make only very small ones. Fidelity, for example.

Many Vanguard stock index mutual funds can be converted to the ETF share class in an overnight conversion without selling and re-buying.

There is no tax-free exchange privilege either between different ETFs or mutual funds.

There are still kinks to be worked out to force ETFs to behave like mutual funds. It's still not possible to transfer fractional ETF shares between different firms, for example. And fractional and by-the-dollar ETF purchases, and automatic purchases, are only recent inventions with quirks. Whereas that has been solved for mutual funds for many decades. So Vanguard mutual funds are a 100% safe choice.

[Sodak]

I have a fidelity account do you know if there is a tax difference in the fidelity index funds vs fidelity ETFs?

[Makefile]

Fidelity doesn't offer their own index ETFs. They previously (and maybe still do) had a partnership with iShares, but that isn't really relevant now that there are no commissions on buying any ETF. You could buy Vanguard ETFs.

I mentioned Fidelity because their index mutual funds have successfully avoided making big capital gain distributions for many years. That may or may not continue. Either way, stick with the plain ones (not ZERO) in case you ever want to move away from Fidelity.

[Squirrel208]

I have a fidelity account do you know if there is a tax difference in the fidelity index funds vs fidelity ETFs?

This Fidelity investor education article sums it up pretty well: ETFs vs. mutual funds: Tax efficiency.

As mentioned previously, Fidelity doesn't currently offer index ETF funds, which is why they permit their clients to purchase Vanguard index ETFs without incremental sales loads or transaction fees. We currently hold the majority of our equity positions in Vanguard's VTI ETF in our various Fidelity accounts expressly for those reasons.

[typical.investor]

I have a fidelity account do you know if there is a tax difference in the fidelity index funds vs fidelity ETFs?

Yes, the ETF index funds are a little more tax efficient than the index mutual funds. Both are index funds by the way. I just mention it as there are actively managed ETFs

Whenever I have looked at mutual fund distributions, it seems that over time the difference is about 0.03% (depending on your tax bracket of course) and time period you look at.

Whether or not that is meaningful, I don't know. Different funds have different policies on share lending, and follow different indexes and things like that so I don't think it is possible to say an ETF is always definitely preferable.

With a large taxable (relative to tax deferred since I was an expat for many years and couldn't increase tax sheltered amounts), I prefer ETFs. If you have a strong preference for mutual funds (for automatic investing or not having to deal with bid/ask), then it's probably worth using them.

Keep in mind though, that ETFs do not eliminate the taxes on the small yearly capital gains that mutual index funds sometimes issue, but rather defer them. The ETF mechanism will give you the same gain as the mutual fund does, but with a little less in cost basis. For me with little in tax sheltered, I like that because my income will be lower when I need to sell them to fund living and more will fall into the zero percent capital gains bracket, and it helps cope with my tax-deferred envy. Again, others find the bid/ask process and paying a spread to be undesirable.

Index funds in taxable - whether they are an ETF or have an ETF mechanism like Vanguard's or not are tax efficient and good for your financial health.

[Squirrel208]

I have a fidelity account do you know if there is a tax difference in the fidelity index funds vs fidelity ETFs?

Yes, the ETF index funds are a little more tax efficient than the index mutual funds. Both are index funds by the way. I just mention it as there are actively managed ETFs

As previously mentioned upthread, Fidelity doesn't offer passive equity market index ETFs similar to Vanguard's VT, VTI, VOO, VBR et al.

The full list of available Fidelity ETFs is available here on Morningstar.

[ruralavalon]

I have a fidelity account do you know if there is a tax difference in the fidelity index funds vs fidelity ETFs?

This Fidelity investor education article sums it up pretty well: ETFs vs. mutual funds: Tax efficiency.

As mentioned previously, Fidelity doesn't currently offer index ETF funds, which is why they permit their clients to purchase Vanguard index ETFs without incremental sales loads or transaction fees. We currently hold the majority of our equity positions in Vanguard's VTI ETF in our various Fidelity accounts expressly for those reasons.

Fidelity also offers iShares ETFs without transaction fees, link

[SaveFerris]

This Fidelity investor education article sums it up pretty well: ETFs vs. mutual funds: Tax efficiency.

As mentioned previously, Fidelity doesn't currently offer index ETF funds, which is why they permit their clients to purchase Vanguard index ETFs without incremental sales loads or transaction fees. We currently hold the majority of our equity positions in Vanguard's VTI ETF in our various Fidelity accounts expressly for those reasons.

Fidelity also offers iShares ETFs without transaction fees, link

Fidelity does not charge transaction fees on any ETFs that I am aware of

[typical.investor]

Yes, the ETF index funds are a little more tax efficient than the index mutual funds. Both are index funds by the way. I just mention it as there are actively managed ETFs

As previously mentioned upthread, Fidelity doesn't offer passive equity market index ETFs similar to Vanguard's VT, VTI, VOO, VBR et al.

The full list of available Fidelity ETFs is available here on Morningstar.

I was simply addressing the question of whether index mutual funds offered by Fidelity are less tax efficient that ETFs. ETFs are very portable you know, and one has access to many fund families via ETFs. The fact that you would have to use an index ETF from a different provider in no way changes how tax efficient that are/are not relative to the Fidelity index mutual funds.

I am afraid I don't follow your point. No, Fidelity doesn't offer index ETFs but why does that matter when choosing between and index mutual fund from Fidelity which doesn't have and ETF share class and an ETF in taxable?

[Sodak]

Thanks everyone for the help and input. I believe I’m going to go with IVV which is the I shares s&p 500 etf. Fidelity has a partnership with I shares so I don’t believe there’s any fees for purchasing it. Thanks

[livesoft]

Thanks everyone for the help and input. I believe I’m going to go with IVV which is the I shares s&p 500 etf. Fidelity has a partnership with I shares so I don’t believe there’s any fees for purchasing it. Thanks

As noted previously, Fidelity does not charge commissions to buy and sell most index ETFs. That means that ETFs such as VTI, VOO, IVV, ITOT, VXUS, BND, IXUS will not have commissions to buy and sell them at Fidelity. Actually, many other brokerages also do not charge commissions nowadays, so the fact that Fidelity does not charge commissions is not an advantage that Fidelity has.

Can I trade one etf for another without it being a taxable event? Thanks for the help and info.

In a taxable account, one cannot trade one ETF for another without it being a reportable event on your US Form 1040. Whether selling ETF shares create taxes for you depends on whether you sell for a profit or not AND what your tax rate on capital gains might be. That tax rate could be as low as 0%. That is, "taxable" is not exactly the same as "reportable."

Buys or purchases are not reportable until the shares are sold. Please read IRS Publication 550 along with the instructions to Form 1040 for more information about all this.

One more thing: All brokerages will collect a small fee that is imposed by the SEC (US Securities and Exchange Commission) from the money you get from selling shares. This is NOT a commission for selling. From time to time we read on bogleheads.org people asking questions about this.

[AnEngineer]

Thanks everyone for the help and input. I believe I’m going to go with IVV which is the I shares s&p 500 etf. Fidelity has a partnership with I shares so I don’t believe there’s any fees for purchasing it. Thanks

Consider selecting investments in taxable not substantially identical to investments in tax advantaged accounts so that if/when you want to tax loss harvest you don't have to worry about the wash sale rule.

[jeffyscott]

Keep in mind though, that ETFs do not eliminate the taxes on the small yearly capital gains that mutual index funds sometimes issue, but rather defer them. The ETF mechanism will give you the same gain as the mutual fund does, but with a little less in cost basis.

And while ETFs only defer these taxes (unless you die without ever selling), any savings on the ER is a permanent, real savings. So since Fidelity index mutual funds generally have lower ERs than corresponding ETFs, they may actually come out ahead depending your tax situation and when or if you sell.

[Nowizard]

From our standpoint, we consider what are the simplest aspects for our portfolio. In retirement funds, depending on whether you have full ability to select assets or not based on your type of retirement funds, you could be choosing from a list of assets provided by your retirement plan or without limitation if your retirement assets were individually created. Changes within either type do not result in tax consequences whether you buy/sell (it is actually exchanging rather than selling), receive distributions, etc. No capital gains reported annually, no tax consequences until withdrawal, period. You could have a combination of ETF's, funds, etc. depending on your plan. In our case, we use funds since we are only concerned about longer term results and are not going to make intraday trades as could occur with ETF's.

Taxable accounts are a different matter. Similarly, with a longer term focus, we primarily use funds but do have a very few individual stocks from time-to-time. Of course, you can trade those during the day. If we had taxable funds we might trade during a given day, we would almost certainly have those in ETF's. Another consideration for ETF's is the distributions, capital gains, etc. that would require annual IRS reports whether from funds or ETF's. Another consideration for ETF's is one's individual tendency to become concerned during a particular market response and impulsively sell during a day when that would not have occurred with a fund.

Individual circumstances differ. For example, we are financially stable and can withstand downturns while choosing to do so based on the belief funds will quickly or eventually recover. A friend with a smaller portfolio does react to daily or a few days changes when the market goes down, and is more reactive when general predictions are of an upcoming downturn. He is market timing from our perspective, engaging in asset preservation from his own. Those are examples of both differing interpretations and differing circumstances that affect investing.

[AnEngineer]

Keep in mind though, that ETFs do not eliminate the taxes on the small yearly capital gains that mutual index funds sometimes issue, but rather defer them. The ETF mechanism will give you the same gain as the mutual fund does, but with a little less in cost basis.

And while ETFs only defer these taxes (unless you die without ever selling), any savings on the ER is a permanent, real savings. So since Fidelity index mutual funds generally have lower ERs than corresponding ETFs, they may actually come out ahead depending your tax situation and when or if you sell.

Not quite. By paying taxes on capital gains distributions (and dividends, but that's common to both mutual funds and ETFs), you experience a tax drag on the performance of your investments each year. Because you lose some each year there's less to grow.

[jeffyscott]

And while ETFs only defer these taxes (unless you die without ever selling), any savings on the ER is a permanent, real savings. So since Fidelity index mutual funds generally have lower ERs than corresponding ETFs, they may actually come out ahead depending your tax situation and when or if you sell.

Not quite. By paying taxes on capital gains distributions (and dividends, but that's common to both mutual funds and ETFs), you experience a tax drag on the performance of your investments each year. Because you lose some each year there's less to grow.

A higher expense ratio is also a drag on the performance in the same way. So there's really no difference in that regard between, say, a mutual fund with a 0.015% ER plus 0.015% in extra tax drag due to tax on capital gain distributions and an ETF with an ER of 0.03% and no capital gain distributions.

The difference is the avoided "tax drag" from not having capital gain distributions may be partially offset by taxes paid upon selling, since the capital gains will be larger. In contrast, a lower ER does not create higher taxes when selling (though it would mean slightly larger dividend distributions).

So each year in this example both the ETF are losing 0.03% each year to taxes and expenses. However half of that 0.03% for the mutual fund is reducing taxes that will be due when sold.

[AnEngineer]

A higher expense ratio is also a drag on the performance in the same way.

My point was just about capital gains distributions, which could be large depending on the fund and year.

Expense ratios also create a drag, though you should look at the particular funds available. In my experience in a taxable account when starting investing ETFs tend to have a lower expense ratio than the available lower share classes of mutual funds.

[jeffyscott]

In my experience in a taxable account when starting investing ETFs tend to have a lower expense ratio than the available lower share classes of mutual funds.

Generally, but I guess you overlooked where I specifically stated that I was only talking about some Fidelity index mutual funds that actually have lower ERs than any comparable ETF. FSKAX with a 0.015% ER, for example.

[typical.investor]

Not quite. By paying taxes on capital gains distributions (and dividends, but that's common to both mutual funds and ETFs), you experience a tax drag on the performance of your investments each year. Because you lose some each year there's less to grow.

A higher expense ratio is also a drag on the performance in the same way. So there's really no difference in that regard between, say, a mutual fund with a 0.015% ER plus 0.015% in extra tax drag due to tax on capital gain distributions and an ETF with an ER of 0.03% and no capital gain distributions.

The difference is the avoided "tax drag" from not having capital gain distributions may be partially offset by taxes paid upon selling, since the capital gains will be larger. In contrast, a lower ER does not create higher taxes when selling (though it would mean slightly larger dividend distributions).

So each year in this example both the ETF are losing 0.03% each year to taxes and expenses. However half of that 0.03% for the mutual fund is reducing taxes that will be due when sold.

When you get down to such small differences in ER and tax drag, you would also need to look at revenue from security lending the fund may do as well as fund methodology (is it actually holding the index or just using a statistical technique to sample and replicate it) and possible differences that the index it follows has in order to truly compare costs.

I am not convinced that we can identify the best fund. It will be A if security lending goes well or B if security lending realizes risk or C if XYZ index return better other indexes in our holding period or maybe none of those matter and it comes down to lowest ER or maybe some combination of all the above as well as tax considerations oh and wait what about the funds that see tracking error due their sampling - it could help or hurt.

I personally can't say if a Fidelity ZERO fund, other Fidelity index mutual fund, Vanguard ETF or iShares ETF will do better in taxable in any given time period. For large taxable accounts, I'd prefer an ETF especially as they are portable but if you don't like trading them, then I don't see much wrong with an index mutual fund.