ETF XRAY

ETF Turnover Doesn't Hurt Tax Efficiency

In a recent posting about the rather higher than normal turnover rate for some Powershares exchange-traded funds, I noted that this might impact their tax efficiency. Actually, ETFs create and redeem shares with in-kind transactions that are not considered sales and therefore don't create tax events.

This allows fund managers to purge the lowest cost-basis stocks through stock transfers during the ETF creation and redemption process.

Powershares has a white paper on tax efficiency which walks through this process and also compares tax issues for both mutual funds and ETFs.

Tax efficiency is an ETF advantage that usually doesn't get much attention but over time will have a significant affect on after-tax returns.

By Carl Delfeld of the Chartwell ETF Advisor

End of Year ETF Tax Strategy

ETFs are not only tax efficient but ETFs can also be a useful tool in executing smart portfolio tax planning.

You can use ETFs in tax loss harvesting to re-balance and diversify your overall ETF portfolio. For example, an investor could sell a collection of securites with a loss on a such as healthcare or home construction stocks and then purchase a sector ETF such as the iShares Dow Jones U.S. Healthcare Sector ETF (IYH) or the Dow Jones US Construction Index ETF (ITB).

Switching from a loss position in an actively managed mutual fund to an ETF of course has double barreled tax benefits. First you can take the capital loss without losing the exposure, and secondly, you have a more tax efficient position with a much lower likelihood of future capital gains distributions.

Brett Arends of the Street.com offers some good advice on this issue but don’t forget to seek  professional advice.