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You are here: Home / Beginning Investors / Another Reason To Prefer ETFs Over Mutual Funds

Another Reason To Prefer ETFs Over Mutual Funds

December 7, 2015 By Lowell Herr

ETFs Preferred Over Mutual Funds

If you hold mutual funds in a taxable account be prepared to get hit with a sizable tax bill even if you never sold any funds.  In an article in the Sunday Oregonian it was reported that some funds are declaring a capital gains distribution that could amount to as much as 35% of the funds assets.

When a fund sells a stock it must record whether the sale resulted in a gain or loss.  Funds are now trimming their portfolios of stocks that generated significant gains over the last few years and that is the cause of high distributions falling on mutual fund investors this year.  ETF owners do not receive these surprise tax visits at the end of the calendar year unless they sold shares of ETFs.

Keep in mind that these distributions only impact taxable accounts.  Owners of index funds should see lower distributions as there is not as much buying and selling within index funds.

If one is investing in mutual funds, the very best time to buy is just after a bear market has hit bottom.  Of course these market troughs are difficult to call, but if one is able to do so there are two advantages to buying when the market looks dark.  1) Prices are low and 2) Funds are carrying tax losses.

In the 1970, when I was first researching mutual funds, I would head down to the main Portland library and dig out Weisenberger Reports, a large hard-backed book that carried all the details of the 300 mutual funds in existence at that time.  I recall one bit of information I would look at was the tax liabilities the various funds showed on their books.  Those young enough to remember will recall the Dow Jones Industrial Average topped 1,000 points for the first time in the late 1960s, only to drop to the mid 500s in the mid-1970s.  Nixon was president and the Vietnam War was beginning to wind down.  Buying mutual funds at that time meant there would not be capital gain distributions for several years as it took a number of good years to make up for all the losses the funds were carrying from all those bad years.  Investors today forget that it took about 15 years to come out of the market funk of the 1970s.

I doubt many readers of this blog are holders of mutual funds, but if you are, brace yourself for a tax hit.

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