From the November 2008 issue of Research Magazine • Subscribe!

ETFs vs. Mutual Funds

Earlier this year, during April, May and June, ETF Providers were busy launching new ETFs. Close to 110 new ETFs were unveiled in this three-month span. Most of the 109 ETFs have the unfortunate distinction of having been launched at the worst possible time.

The most recent ICI numbers indicate that even though ETF assets have declined, this is due to market movements and not investors yanking money out of ETFs.

It's quite different for mutual funds. Total stock fund assets stood at $5.6 trillion as of August 31. Investors pulled $50 billion just within the first 10 days of October, according to TrimTabs.

The quarterly statements sent out by mutual fund companies on September 30 do not fully reflect investor's pain. The S&P 500 is down another 27 percent since. Due to the structure of mutual funds you can't even bank on tax write offs. Chances are you'll owe taxes on your mutual fund for 2008. Mutual fund companies are prone to sell profitable holdings to raise cash for distributions. The gains of such holdings are passed on to fund holders. This means, that unless you own your mutual fund within a qualified retirement plan, you still owe taxes, even though your fund might be down 50 percent. How about that for a double whammy?

The redemption process for ETFs is quite different. Therefore ETFs have a history of tax-efficiency. Of course you might have to contend with taxes if you own a short ETF, some of which were issued since April. Short ETFs rule the list of the top 30 best performing ETFs. With ETFs, paying taxes is not such a bad thing. Chances are, you only pay taxes if you sell with a gain.

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