One of the biggest benefits ETFs provide investors is they can cut your tax bill. Because of their legal structure and minimal trading, ETFs typically distribute very little, if any, capital gains to investors. As The Motley Fool explains, the same is not true for mutual funds. Adding salt to the wound this year: some investors are going to be paying heavy taxes on capital gains – – even though their funds might be down 40%!
So, what can you do to protect yourself? If you must buy a mutual fund, wait until after the fund pays out its capital gains before you buy. You can generally check with the mutual fund provider website to find that date.
If you already own a fund and it hasn’t yet paid its capital gains distribution, you can avoid the distribution and still retain much of the performance of the fund by selling the fund and buying a highly correlated ETF at the same time.
One place to start your search for a suitable ETF replacement is at the free correlation calculator here. Click on the field ‘correlation cloud’, then type in your mutual fund ticker along with a few ETFs that you think might be a good match (you need 5 tickers to run the program). Any result in the high 90’s means the ETF is likely a candidate for replacement for your fund.
