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Are you tired of paying capital gains taxes every year? If so, you are not alone. Most investors probably wouldn’t be upset to see them disappear altogether. This week on the Mullooly Asset Management podcast Tom and Brendan have a timely discussion about mutual funds, ETFs, and capital gains. For those looking to get away from capital gains taxes, ETFs are more tax efficient than mutual funds in most instances. This is also something that Tom and Brendan talk about in the podcast.
Every year from around mid-November until the year’s end, mutual funds distribute capital gains to fund holders. These investors have to report these gains and pay taxes on them. This obviously does not apply to you if you own mutual funds inside of a tax protected account like an IRA or another type of retirement account. It is important to research what you buy around this time of year though because you certainly would not want to invest in a mutual fund now only to be slapped with some big capital gains right away.
Tom and Brendan discuss an example of how mutual fund capital gains work for long term investors. They dissect year by year how the process would play out. It is crucial to understand how a mutual fund, or any investment for that matter, works before getting involved.
If investors are truly interested in finding an alternative to mutual funds because they don’t like capital gains taxes, then ETFs could be a great solution to look into. ETFs and mutual funds are similar in some ways, but quite different in others. ETFs are more tax efficient than mutual funds in almost all scenarios. This is because ETFs don’t have year end capital gain distributions. With an ETF, the gain is the difference between what you sell it for and what you bought it for. Very simple. When you buy an ETF, you buy the basket of stocks or bonds exactly how they are at that moment. The same goes for selling, and that is why ETFs are more tax efficient in most instances.
Tune into this week’s Mullooly Asset Management podcast to learn more about mutual funds, ETFs, and capital gains.