Loyal ETF Investors Rewarded With No Tax Bills

Did you have any caffeine today? Have you had any form of exercise this week? For most people, this is just routine and not worthy of discussion. I find for many the same is true with ETFs and capital gains. However, the ETF pie continues to expand with newer investors each year. The persistent lack of a capital tax gain burden simply for holding onto an investment is worthy of celebration.

In recent days, BlackRock, State Street Global Advisors, and Vanguard revealed their estimated ETF capital gains distributions. Actually, let’s try that again.

BlackRock announced that just five of its 427 (1.1%) U.S.-listed ETFs will pass along any capital gain. Meanwhile none of the 138 ETFs offered by State Street Global Advisors nor any of the 82 ETFs offered by Vanguard is expected to share a tax burden. That’s more than 600 ETFs that will have no hidden surprises for its end investors. No wonder so many advisors are shifting to ETFs.

Capital Gains Is Common for Equity Mutual Funds, Rare for ETFs

Those that grew up with mutual funds as the primary vehicle to access stock and bond markets likely have received an annual capital gains or loss even when they did not make any changes to their portfolio. As other mutual fund investors sell shares, fund managers often need to rebalance the fund. In addition, managers may sell stocks that meet objectives or no longer look attractively valued. Such changes can create taxable liabilities for the remaining shareholders.

According to Morningstar data, 81% of U.S. active equity mutual funds paid out taxable capital gains over the past five years. We have already seen some 2023 capital gain announcements for well-known funds like American Funds Growth Fund of America and MFS Value Fund.

In contrast, ETFs trade on an exchange where sellers typically transfer shares to another investor. As a result, ETF companies do not need to sell shares of underlying investments to meet redemptions. When they do, ETFs make in-kind redemptions through authorized participants using low-cost basis securities rather than cash. Such actions limit the likelihood of realizing capital gains.