How Was Your Tax Season?
This article appeared in the May 2019 edition of Nevillewood Living.
of us are comfortable paying taxes on the amount we earn, as well as on the
gain of a profitable investment. Seems a
fair price tag for the privilege of living in a country where freedom is
cherished, and personal and professional opportunities are limitless.
taxes when you have lost money,
however, may feel a bit like having a tooth extracted without pain
medication. Quite a few investors have
felt this pain this tax season, as they have owed taxes on 2018 capital gains
while their portfolio declined in value.
How does this happen? And how can you prevent it from happening to you (perhaps again, maybe this wasn’t the first time?)
couple years ago, we wrote about Exchange Traded Funds (ETFs), comparing and contrasting
them to traditional open end mutual funds.
You may recall, an open end mutual fund that generates capital gains
from portfolio trading activity is required to distribute those gains to
shareholders of the fund on an annual basis.
So, in a year like 2018 when the market was down, a mutual fund may sell
a long term holding for a gain. Even
though the overall portfolio may be down for the year, this sale will generate
a capital gain on which you, a shareholder in the fund, will need to pay
very large mutual fund company (a household name) paid out substantial capital
gains last year to its shareholders, even though its stock portfolios lost
money for the year. You can imagine the
surprise of the funds’ shareholders.
Many were probably asking Where’s the
may recall, ETFs are similar to traditional mutual funds in that they offer a
cost effective way to own a diversified portfolio or a particular sub class of
the market. Along with lower costs,
intraday trading capabilities, and more precise allocations, however, ETFs also
offer the benefit of incredible tax efficiency.
exchange traded feature of ETFs (along with the fact that many are passive
vehicles) means that a stock ETF does not trade its portfolio in a way that
generates capital gains. As a
shareholder in the ETF, your gains remain unrealized via the appreciating price
of the ETF, while trading in a traditional mutual fund generates gains that are
realized and thus generate a tax liability.
course, if you want to convert those unrealized ETF gains to cash, you will
need to sell ETF shares and this will generate a taxable realized gain. However, the crucial difference here is that you will be more in control of when this
gain is realized, vs with a traditional mutual fund where you relinquish that tax
planning control to the fund manager.
Consider using ETFs in your portfolio because of the several advantages they offer over traditional mutual funds. For many, 2018 was a stark reminder in particular of the potential tax advantages of using ETFs within your portfolio.
The opinions voiced in
this material are for general information only and are not intended to provide
specific advice or recommendations for any individual. All performance
referenced is historical and is no guarantee of future results. All indices are
unmanaged and may not be invested into directly.