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Investing Specialists

Index Funds and ETFs: Tax-Efficient, But Not Always

Don't assume one of these products will be a good fit for a taxable account without looking under the hood.

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JP Morgan Equity Index fund (OGEAX), an S&P 500 index tracker, is estimating a 9% capital gains distribution in 2016, following on the heels of an even larger distribution in 2015. That's no doubt an unwelcome development for investors who had been counseled to use broad-market index funds in their taxable accounts, but it shouldn't come as a complete surprise. While many equity index funds and exchange-traded funds (especially those that are widely held) have historically been tax-efficient, they're not a foolproof way to avoid taxes until you yourself sell. Special events, such as sizable asset outflows, can trigger larger than expected capital gains payouts. Other funds, despite falling under the index/ETF umbrella, aren't tax-efficient in the first place because they generate lots of income and/or short-term capital gains.

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