It's Christmas in July when you invest in an ETF
Tax. There we said it. There is no way anyone would open an email with tax in the title. Tax, like Christmas, is only thought about once a year, but for most people it’s more like Christmas with the in-laws: you don’t really want to have to think about it but you have to do it and it’s more than likely going to be a chore...
Tax. There we said it. There is no way anyone would open an email with tax in the title.
Tax, like Christmas, is only thought about once a year, but for most people it’s more like Christmas with the in-laws: you don’t really want to have to think about it but you have to do it and it’s more than likely going to be a chore.
It’s tax time now and if you have three minutes you will get a tax gift after reading this (metaphorically speaking, of course). It really is Christmas in July!
Exchange-traded funds, or ETFs, are managed funds that you buy on the ASX and that have tax benefits compared to unlisted managed funds. With unlisted managed funds your tax liability goes up when other investors desert the fund. ETFs, being listed on ASX, have a mechanism to mitigate this risk.
With unlisted managed funds, if an investor redeems from the fund before a distribution is made, he leaves behind his share of any upcoming distributions for remaining investors, along with the associated tax liability. The departing investor may also have to be paid out through the sale of fund assets, leaving the remaining investors with an increased capital gains tax (CGT) liability. This does not happen with an ETF. Investors sell their units on the exchange to other investors or the market maker. A market maker is someone whose job it is to ensure there are units available for investors to trade (buy and/or sell). The market maker may redeem its units in the ETF but the good news is when it does, its CGT attached to those units redeemed goes with them. The ETF therefore minimises the impact of redemptions by other investors and the associated potentially higher CGT liability.
Those who have had a bad tax experience with an unlisted managed fund will understand. An ETF won’t hit you with a large taxable distribution the way an unlisted actively managed fund can do due to client redemptions.
Added to this mechanism of sheltering investors from other redeeming investors, ETFs are index funds, which means they are “passively managed” as opposed to so-called “actively managed funds.” Actively managed funds employ stock-picking portfolio managers who buy and sell their investments more rapidly because they are being paid higher fees to find the best stocks. In contrast, most ETFs purchase the securities (or a sample of them) of the index they seek to track, and so typically have less trading, or turnover, of the stocks compared to actively managed funds.
The tax consideration here is that a higher turnover in the portfolio each year brings forward capital gains tax liability. The question then becomes whether the fund manager’s ability to pick better shares outweighs this higher tax cost. As most active fund managers do not beat the index after fees, it is unlikely that they will deliver a better after-tax outcome.
There. Three minutes and you got two tax gifts.
- 1. ETFs are generally a tax-efficient investment vehicle because they minimise exposure to CGT when other investors redeem.
- 2. As passive funds, ETFs typically have low turnover and therefore generate lower levels of capital gains tax compared to actively managed funds.
Happy tax time! Now you can think about organising that Christmas dinner.
Market Vectors ETFs are available on the ASX.
Disclaimer: This announcement is issued by Market Vectors Investments Limited ABN 22 146 596 116 AFSL 416755 (‘Market Vectors’) as Responsible Entity of the Market Vectors Australian ETFs (‘Market Vectors ETFs’). This information is general in nature and does not take into account your objectives, financial situation or needs (‘your circumstances’). Before making an investment decision in relation to a Market Vectors ETF, you should read the applicable Product Disclosure Statement (‘PDS’) and with the assistance of a financial and tax adviser consider if it is appropriate for your circumstances. The PDSs are accessible from marketvectors-australia.com or by calling 1300 68 3837. Past performance is not a reliable indicator of future performance. The Market Vectors ETFs are subject to investment risk, including possible delays in repayment and loss of capital invested. No member of the Van Eck Global group of companies guarantees the repayment of capital, the performance, or any particular rate of return from the Market Vectors ETFs. Market Vectors® and Van Eck® are the registered trademarks of Van Eck Global.