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While ETFs encounter fewer taxable events than mutual funds, mutual funds require more frequent rebalancing, which can create taxable events.
ETFs tend to be more tax-efficient. (Representative Image)
Exchange-traded funds (ETFs) and mutual funds are two popular investment options, but they differ significantly in their tax efficiency. While ETFs encounter fewer taxable events than mutual funds, mutual funds typically require more frequent rebalancing, which can create taxable events. This is because ETFs transfer shares from one investor to another without needing to redeem shares like mutual funds.
Hence, before investing your hard-earned income, understanding these differences is important.
What Are ETFs and Mutual Funds?
Exchange-Traded Funds (ETFs): ETFs are passive investment funds that are traded on the stock exchanges NSE & BSE like individual stocks. They can be bought and sold throughout the trading day at market prices, which may differ from their NAV due to market fluctuations. ETFs replicate the performance of their underlying indices within sectors by providing diversified exposure to a wide range of assets, commodities or regions.
Mutual Funds: Mutual Funds pool money from different investors to create a diversified portfolio of stocks, bonds, or other financial products. These funds, actively or passively managed by fund managers of AMCs, are bought or sold at the end of the trading day at a price known as the fund’s Net Asset Value (NAV). This value reflects the total value of all the fund’s assets divided by the number of shares outstanding.
ETFs Vs Mutual Funds: Which Is Better For Tax Saving?
Tax laws are the same for ETFs and mutual funds in terms of capital gains and losses and dividends. ETFs tend to be more tax-efficient because their structure allows investors to buy and sell from one investor to another without triggering capital gains distributions. Hence, most ETFs don’t need to change their holdings frequently. Instead, the ETF manager can create or redeem ‘creation units,’ or baskets of the underlying securities.
As for mutual funds, the frequent buying and selling of securities within actively managed funds can generate capital gains taxes more often. Even if the market value of a mutual fund falls, when an investor sells shares back, it might trigger a tax liability. Also, fund managers must constantly rebalance the fund as investors buy or sell shares. This constant change can create taxable events for shareholders.
A team of writers and reporters decodes vast terms of personal finance and making money matters simpler for you. From latest initial public offerings (IPOs) in the market to best investment options, we cover al…Read More
A team of writers and reporters decodes vast terms of personal finance and making money matters simpler for you. From latest initial public offerings (IPOs) in the market to best investment options, we cover al… Read More
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