Exchange Traded Fund defined

Exchange Traded Fund defined

An exchange traded fund (ETF) is a pool of stocks or commodities trading as a single stock on a stock exchange. Hence the name exchange traded fund. Unlike mutual funds, an exchange traded fund may be bought on margin, sold short, traded intraday, or in any other way traded like a stock. As with stocks, investing in an exchange traded fund will incur trading costs. Often, an exchange traded fund will mimic a stock index; popular exchange traded funds are the DIA (mimics the Dow Jones Industrial Index) and the QQQQ (mimics the NASDAQ 100). Other exchange traded funds can track specific industries, regions, or investing styles. Exchange traded fund family examples are iShares, VIPERs, and SPDRs.
Comment: Image source. Some of the ones I use: AGG, BND, AMLP, PEY, and DLN.

Image below displays the top 10 holdings of DLN. Simplified investing.


  1. Article that speaks to the tax efficiencies of ETFs: Not a Pretty Market Close—Here's Why:

    There is already some normal, end-of-year movement of ETFs that is happening. But there's an factor this year: ETFs almost never distribute capital gains, and with anxiety about capital gains tax increases growing, that is a big plus.

    There are two types of capital gains: 1) capital gains from buying and selling in a portfolio, and 2) capital gains from selling your individual position in a stock, mutual fund, or ETF.

    Most ETFs never distribute capital gains from buying and selling in the portfolio because 1) most are not actively managed, so there is relatively little buying and selling within the funds, and 2) ETFs have a more tax efficient structure due to the way shares are created and redeemed.

    In an actively traded mutual fund, if I sell $10,000 of that fund back to the fund, the fund has to go and sell the underlying stocks in that fund, and that creates a taxable event for me.

    In an ETF, there is no taxable event from buying and selling the underlying portfolio. If I want to sell $10,000 of an ETF, I can do it by selling to my broker. It may be bought by another natural buyer, or by a market maker. The market maker will go to the ETF fund itself and delivers those shares, and the fund in return will give the underlying stocks back to the market maker. That does not trigger a capital gain.

    Come year end, the ETF and its shareholders will not owe any taxes due a distribution of capital gains. There will be a capital gain from selling my position, but I won't get a separate bill on capital gains distributions.

    Get it? It's a more efficient tax structure. That's why ETFs make more sense for many investors.

    Here's the data on equity ETFs, from Index Universe,

    1) Only 20 of 756 equity ETFs paid distributions—less than 3% of all equity ETFs, and again, the gains they did pay out were tiny.

    2) By comparison, 24 percent of equity mutual fund share classes made a capital gains distribution.

    I'm not expecting everyone to go out and sell their mutual funds to buy ETFs. That wouldn't make much sense.

    But I do think that a lot of new capital will continue to flow into ETFs.


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