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Are Exchange-Traded Funds Right for You? Considering Efficiency

Are Exchange-Traded Funds Right for You? Considering Efficiency

Redemptions made by large investors are paid "in kind," again protecting shareholders from taxable events. All of this should make ETFs more tax-efficient than most mutual funds. Keep in mind, however, that ETFs can and do make capital-gains distributions, as they must still buy and sell stocks to adjust for changes to their underlying benchmarks. They simply tend to do so less often than mutual funds must.

Things To Know

  • ETFs are generally more tax-efficient than most mutual funds.

When it is the most cost-effective choice

On the cost front, an ETF often will be the most cost-effective choice for those who use discount brokers, invest a single large lump sum of money, and are willing to hold the investment for the long term. For all others, an exchange-traded fund isn’t likely to have a big cost advantage over a plain-vanilla, low-cost index fund.

Your options for ETFs

The ETF universe is flush with options that focus on a single market sector, industry, or geographic region. This means that exchange-traded funds can offer a way to invest in a corner of the market without having to load up on just one or two individual stocks. If you’re inclined to invest in more highly-focused ETFs, it makes sense to be a contrarian, not to chase what’s been hot recently. Too often, by the time a hot-performing market segment catches investors’ eyes, it’s just about to cool down. Unfortunately, some ETF providers have a bad record of launching new ETFs in faddish corners of the market, a practice that tends to encourage investors’ worst instincts.