What’s the difference between open-end mutual funds and exchange-traded funds (ETFs)? Here’s a side-by-side look at the two types of funds:
When investors sell mutual fund shares, the fund usually sells underlying assets to satisfy the redemptions. If the assets have appreciated, taxable capital gains are generated and then are later distributed to investors. So regardless of whether they sold shares or not, the fund’s investors may incur some capital gains liability.
With ETFs, shares are purchased directly from other shareholders, rather than the fund itself, so the ETF is not generating a capital gain that will need to be later distributed. Investors do owe tax with respect to ETFs — and mutual funds — holding stocks that pay dividends or bonds that pay taxable interest. Also, ETF investors will owe capital gains tax on any gains they realize from selling their own ETF shares.
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