Many of you likely face the unpleasant reception of a December alert from a mutual fund you own that it took capital gains during the year. That means you face capital gains taxes.
But your worries may soon be gone. More than 70 mutual funds have converted to exchange-traded funds since early 2021, according to Morningstar Direct. And that includes about 35 so far this year.
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“There are several reasons behind this trend,” according to a Fidelity Investments report. “Near the top of the list: Investors generally love ETFs, with soaring fund flows into ETFs as evidence.”
Thus, “in the case of most mutual funds that have converted to an ETF, the fund company has hoped to attract more investors to the ETF compared with the mutual fund,” the report said.
“Another factor … is that the converting fund retains historical performance,” the report said. “This may be beneficial for attracting investors that prefer established funds whose historical performance can be assessed.” Obviously an ETF set up from scratch has no performance track record.
Impact on investors
So what does this mean for you? Of course you get the benefits of being able to trade your ETF throughout the day, as opposed to only once a day (at closing price) for a mutual fund.
Probably more importantly, ETFs are structured to avoid capital gains taxes. The structure is complicated to explain, as it involves in-kind shares. Suffice it to say: your tax bill should go down when you’re holding an ETF rather than an actively managed mutual fund.
Here are three ETFs that have garnered Morningstar’s top rating of gold.
1. Invesco S&P 100 Equal Weight ETF (EQWL) -). An equal-weight fund gives equal weight to each of the index’s stocks. That contrasts with the regular S&P 100, in which stocks are weighted by their market capitalization.
2. iShares Core Aggressive Allocation ETF (AOA) -). The fund tracks an index of stock and bond funds with an aggressive risk allocation strategy.
3. iShares Fallen Angels USD Bond ETF (FALN) -). The fund tracks an index of high yield corporate bonds that were previously rated investment grade.
