ETF Capital Gains Distributions are Virtually Non Existent

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Back on November 20th I wrote a piece called An ETF Tax Swap Idea for the holidays! In that post I talked about avoiding potential mutual fund capital gain distributions and moving into ETF’s.

As a part of that post, I included a link to a page detailing the 2007 capital gains distributions for ING, so as to provide further evidence of what a fund investor can expect.

One thing I did not do in that post was provide any information on the kind of year end distributions you can expect for owning an ETF in 2007.

So I’d like to address that…

Let’s go ahead and take a closer look at the 2007 estimated capital gains distributions for the iShares ETF family, one of the largest and most recognized distributors of ETF’s. I use many of the iShare ETF’s to construct client investment portfolios.

As of this writing, iShares offers 146 different ETF’s and they are always coming out with new product offerings. I constantly get emails and product fliers alerting me to their ever expanding portfolio of ETF’s.

This is a good thing because the more ETF’s there are, the more diversification and non correlation potential there is. And that’s music to my little financial planning ears.

The bottom line

Of the 146 ETF’s they offer, 130 of them will have ZERO capital gain distributions for 2007.

Of the 16 ETF’s that WILL have a year end distribution, only 4 have a distribution over .1%. Of those 4 ETF’s, only 2 will have an estimated distribution over .25%. And one of these ETF’s, with an expected distribution of .50% (symbol: EWZ) is the Brazil Index Fund, which had 1 year performance (through 09/30/07) of 95.81%.

A .50% capital gains distribution is not a bad trade off for a 1 year return of 95%. I’m sure there’s more than a few GenXer’s out there that wished they had this ETF in their portfolio, I know I do.

Remember, capital gain distributions tend to come from areas of the market where the performance has been good, and these days that kind of performance often comes from emerging markets.

One of the core benefits

A beautiful things about ETF’s is the tax efficiency that investors are afforded. Even when a fund’s performance is exceptional, like in the above example, the distribution can be small. The overwhelming majority of the iShares ETF’s had no capital gains distributions for 2007 and that speaks volumes. What do I always say around here?

My motto

“When choosing your investments, you want to put a premium on tax efficient funds with low expenses. At the end of the day you can only play a part in controlling your costs, the performance will have to take care of itself.”

A leg up on the competition

There are 2 big reasons why ETF capital gains distributions will always be significantly lower than those of actively managed mutual funds:

1- there is no active buying and selling of positions, like there is by a mutual fund manager. ETF’s are passive investments; positions are only bought or sold if there’s a change to the underlying index it follows, which doesn’t happen all that often. This is the secret behind their tax efficiency.
2- it’s very possible to inherit capital gains created by other investors in the mutual fund. With ETF’s, because they trade like stocks, you 100% control your own capital gains experience.

You get the best of both worlds

ETF’s combine the investment diversification of a mutual fund with the tax efficiency and control of an individual stock (or bond). Investors get the benefits of both those worlds, without suffering the drawbacks of either…

For a refresher on the core benefits surrounding ETF’s check out the related posts below, especially Understanding the Tax Efficiency of ETF’s and 5 Reasons I Love ETF’s…

Tags: ETF, ETF capital gains distribution, ETF Tax Efficiency, Exchange Traded Funds, iShares ETFs