What makes ETFs more efficient than Mutual Funds in a brokerage account?

 

1. Recap on ETFs & Mutual Funds
   1. Exchange-traded fund (ETF)
      1. Similar to a mutual fund, an EFTis a basket of securities that trades on an exchange just like a stock does. It’s a type of pooled investment security that can be purchase or sold on a stock exchange the same way regular stock can (unlike mutual funds).
      2. An ETF can be structured to track anything from the price of an individual commodity to a large and diverse collection of securities. ETFs can even be structured to track specific investment strategies.

• Offer the same diversification benefits as mutual funds but often at a much lower cost to an investor.

1. Great versatility, letting you easily move money between specific asset classes, like stocks, bonds, or commodities.

 

1. Mutual Fund
   1. A mutual fund is a type of financial vehicle made up of a pool of money collected from many investors to invest in securities like stocks, bonds, money market instruments, and other assets. Mutual funds are operated by professional money managers, who allocate the fund’s assets and attempt to produce capital gains or income for the fund’s investors.
   2. A mutual fund’s portfolio is structured and maintained to match the investment objectives stated in its prospectus.
2. Tax Efficiencies of ETFs
   1. Structure
      1. Investors in both mutual funds and ETFs are taxed each year based on the losses and gains incurred within the portfolios.
      2. ETFs are structured in such a manner that taxes are minimized for the holder of the ETF and the ultimate tax bill (after the ETF is sold and capital gains tax is incurred) is less than what the investor would have paid with a similarly structured mutual fund.

• However, ETFs engage in less internal trading and this less frequent trading creates fewer taxable events.
  1. Generally, holding an ETF in a taxable account will generate less tax liabilities than if you held a similarly structured mutual fund in the same account.

1. Unless you are investing through a 401(k)/tax-favored vehicles, mutual funds will distribute taxable gains to you (even if you just held the shares) while an all ETF portfolio’s tax will generally only be a concern if/when you sell the shares.
2. Actively managed mutual funds tend to have a higher tax cost than index funds because as a manager liquidates and purchases investments in an attempt to beat the market, capital gains are realized more frequently and those are taxed. The more activity in a fund, the more those taxes add up.

3. Expense ratios
   1. A passive management style usually results in lower expense ratios vs actively managed funds. ETFs carry expense ratios as low as 0.05%
   2. Mutual funds carry higher expense ratios due to not needing as much active management as an ETF