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ETF Specialist

ETFs Deliver on Their Tax-Efficiency Promise

Even against open-end index funds, ETFs can't be beat for low-tax distributions.

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One of the key reasons for someone to choose an ETF over an open-end fund is that ETFs are supposed to be more tax-efficient in terms of delivering low capital gains distributions. For long-term investors with funds in taxable accounts, capital gains distributions are a nuisance that can force you to have to sell some of your holdings to pay taxes if you don't have cash on hand to do so. Worse, these distributions may come at a time when your tax bracket is higher than it would be in your retirement. Every advisor worth his salt knows that managing these capital distributions is key to maximizing the return of a passive investing portfolio.

So Are ETFs Tax-Efficient?
To find the answer to that question, I asked Morningstar's Corporate Research Group to run a study comparing ETFs to the toughest competition we could find: open-end index funds. In the study we tabulated the capital gains distributions for equity-based ETFs across 27 broad-based indexes. We did this over five-year, 10-year, and 15-year periods. We then compared that to all the relevant open-end index funds that tracked the same benchmark, and aggregated those distributions. When reading the chart, 0.00 means that there were no capital gains distributions. A number, for example 1.06, means that 1.06% of the fund's or the average fund's NAV was paid in capital gains distributions during that time period. Finally, NA means that the fund didn't exist in that time period. Unfortunately, most ETFs are relatively young, so the longer periods are bereft of comparison data.  

Scott Burns does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.