This year, our tax clients have had to pay taxes on over $300,000 on capital gains. Capital gains could be avoided by using exchange traded funds. Exchange traded funds give the investor the same diversification as mutual funds, while also providing tax efficiency.
I will give you my best explanation. In a mutual fund, you own a collection of stocks with a number of other investors. The actions of the other investors will affect you as you are invested in the same fund. When they sell, you may also pay a capital gain as a result.
In an exchange traded fund, you own the exchange traded fund by yourself. Your share owns slices of different stocks. When you sell your share, you pay taxes. When large numbers of investors buy or sell shares of the fund, the fund company creates or destroys shares to accommodate the flow of the investments. Tax effects do not hit your share based on other investor’s behavior.