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Post by Deleted on Sept 15, 2023 19:01:57 GMT
Citing 2 mutual funds that outperformed is pretty thin evidence that active management is superior, even if you believe past performance predicts the future.
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Post by retiredat48 on Sept 15, 2023 19:29:35 GMT
_@gary1952
retiredat48 , You are correct. I don't fully understand the tax efficiencies of ETFs. Saying they are more tax efficient doesn't explain how they are more tax efficient. The part I understand is they are more tax efficient for frequent traders. You are a frequent trader. Also, the only reason to defer taxes is if taxes will be lower later. That is not always true and, for most of us, it is not possible to defer taxes forever. If an investor has to withdraw money to live on taxes become due. My wife will need to withdraw money to live on. We are currently taxed at the married rate. She will be taxed at the single rate. Deferring taxes now will mean higher taxes later. Taxes that reduce her livable income. This is most likely true for all investors whose spouses will need the withdrawals to live on.
People say ETFs save on taxes. How?
Mustang ,...OK, one more pass through. You are incorrect (not understanding), by not seeing that ETFs trade underlying stocks DAILY. If investors on balance on a given day exit the ETF, the etf must sell underlying shares. This would result in huge cap gains in the fund, over time. Instead, this is done by the fund with what is called "creation units."...google details if you like. But the process ends up being very little or no cap gains issued to the shareholders, PER IRS RULES. It has nothing to do with shareholder frequency of trading. And no, deferring taxes to later does not require lower tax brackets to be beneficial. Even if same tax rate, a tax deferred for 20 years is just that. One does not owe anything to the gvt, and has their money fully invested. An open ended mutual fund does have annual cap gains distributed, MAY have annual taxes due in larger income types, and is thus to be avoided. Same reason any IRA benefits you...you defer taxes as long as you can...wealth grows. Someday, you may have a tax due. That is where the retirement date selected comes into play. When you "have enough" you "HAVE ENOUGH." An option is to retire...or keep working and build up even more assets to be taxed at a far later day. R48
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Post by FD1000 on Sept 16, 2023 4:06:40 GMT
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Post by Mustang on Sept 16, 2023 8:24:05 GMT
retiredat48 , I had never heard of a “creation unit” before and I now understand why most investors do not look under the hood of an ETF. They are very complicated consisting of a primary market and a secondary market. Only Authorized Participants (APs), typically large financial institutions, are allowed to invest in the primary market. Retail investors only buy and sell in the secondary market. Typically, EFTs invest in broad and narrow market indexes but there are also actively managed ETFs that roll their own mix of securities. The AP runs the “creation unit” creation and redemption process.” Using an index as an example, cash is used to buy shares of the security (the index fund). “Creation units” are formed by an in-kind transfer of security and are kept in a trust fund. For example, 50,000 shares of an S&P 500 index fund form one “creation unit” which is transferred to the trust fund. This is an in-kind transfer has no tax implications. The trust fund then provides ETF shares (legal claims on the shares in the trust) which are sold by brokerages in the secondary market. Like mutual funds, ETF shares in circulation are added and subtracted daily to balance supply and demand. When ETF shares are bought and sold there is little effect on the underlying securities in the trust fund. When ETF shares are redeemed their cost basis is the cost paid for the ETF shares not the costs of the underlying securities in the trust fund. Large redemptions can affect the primary market. In the primary market the AP can only redeem “creation units.” The AP accumulates redeemed ETF shares until they constitute a “creation unit”. In this instance, 50,000 shares of the S&P 500 Index Fund. The AP then redeems the “creation unit” with the issuer receiving back shares of the index fund. A fee is incurred if they get cash in-lieu of securities. These shares are then sold - selling the shares with the lowest cost basis first. This increases the average cost of the overall ETF holdings. Again, this does not affect the retail investor. Their capital gains are based on cost they paid for the ETF shares. Policy makers expressed concern that the APs would step away during periods of market stress. I suppose that could happen but it didn’t happen in 2020. A comparison of 2019 to 2020 showed that APs facilitated a significantly higher volume of ETF creation and redemption in 2020 suggesting that they stepped up instead of stepping away. I didn’t see anything on what would happen if they had stepped away. This is going to take a while to digest. But I now see how dividend pass through and how capital gains are deferred. Capital gains are held in the trust fund and do not pass through until the ETF shares are sold. While none of the articles mentioned what the trust fund does with these distributions I assume (and could be totally wrong) that they are used to create additional "creation units" increasing the value of the underlying assets and the value of the ETF. (I skimmed over the part about the Role of Arbitrage which keeps the value of the underlying assets and the ETF share price the same.) FD1000 , The ETF had ever so slightly lower returns than the index fund it was based on. My guess is that was because of administration fees. The index fund's ending balance was $50,644. The ETF's was $50,590. If sold then the capital gain taxes would have been paid a little at a time over the 10 year period for the index fund. They would have been paid all at once at the end when sold for the ETF.
This is the point I was trying to make. I just didn't understand ETFs enough to explain it. Capital gains increase the value of underlying assets in the trust fund. Arbitrage keeps the price of the ETF shares the same as the value of the underlying assets. As re-invested capital gains increase the value of the underlying assets the price of the ETF shares increases. When the ETF shares are sold all of those capital gains come due at the same time. Right now we can afford the taxes. It really isn't a big deal. If we were invested in ETFs, when my wife has to sell she will not only have to pay the taxes on the deferred capital gains but she will pay them at the single rate instead of the married rate.. This will significantly reduce her after tax income. Deferring taxes is not always the best course of action.
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Post by retiredat48 on Sept 16, 2023 15:01:25 GMT
Mustang ,...good...glad you got a glimpse of creation units. Further, you posted: "When the ETF shares are sold all of those capital gains come due at the same time. Right now we can afford the taxes. It really isn't a big deal. If we were invested in ETFs, when my wife has to sell she will not only have to pay the taxes on the deferred capital gains but she will pay them at the single rate instead of the married rate.. This will significantly reduce her after tax income. Deferring taxes is not always the best course of action."R48 comment...well, this is no different than an IRA. You get tax free growth for perhaps decades, then if you redeem anything to live on, taxes may be due. One does not give up investing in IRAs though, as the benefits are huge. Lastly, most people take from their portfolio accounts the amount needed to live on each year, taking into account how much is RMD, how much from a Roth, how much from a taxable holding such as a decades old ETF. You generally do not sell all of everything at once. Your spouse can likely deal with this. R48
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