Why ETFs Are So Tax-Smart

You've probably heard that exchange-traded funds or ETFs have tax advantages over regular mutual funds. But to make the most of the advantages of ETFs, you need to understand why they're so tax-smart for your portfolio.

In the following video, Dan Caplinger, The Motley Fool's director of investment planning, explains the tax benefits of ETFs. He notes that traditional mutual funds often have high turnover, with active managers buying and selling shares and generating capital gains that they're required to pass on to shareholders. By contrast, SPDR S&P 500 (NYSEMKT: SPY  ) , Vanguard Total Stock (NYSEMKT: VTI  ) , and many other ETFs track popular indexes that don't have nearly the turnover that an active fund has. Dan reminds investors that you'll still pay income tax on dividend distributions, with popular dividend ETF iShares Select Dividend (NYSEMKT: DVY  ) passing through dividend income along with most other ETFs, including the two mentioned above. Dan concludes that ETFs have special characteristics that make it easier for them to avoid unnecessary tax liability, which is valuable for investors seeking the highest after-tax returns they can find.

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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 23, 2014, at 8:09 AM, GordonX wrote:

    why not just buy the actual index mutual fund ie VFINX or VFIAX? why are these not mentioned? is there something more tax efficient with index ETFs vs. index funds that i don't know about?

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Dan Caplinger

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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