If I plan to hold an asset for 10 years, the asset is offered as a mutual fund and an etf, with the same 0.25% fee, and quarterly dividends of 100.00, from a tax and reinvestment standpoint, which will be better?

The index ETF is a NTF-fund, and it allows for DRIP.

  • The 100.00 dividend could be any number, but the point being that there is a dividend of some sort
    – pyInTheSky
    Mar 26 '15 at 17:27
  • It is very unlikely that an index etf and the mutual fund tracking the same index, with the exact same yield as the etf will have same 0.25% fee. The fee will be higher for the mutual fund.
    – Victor123
    Mar 26 '15 at 18:13
  • @Victor123 This isn't uncommon, e.g. VTI and VTSAX.
    – Craig W
    Mar 26 '15 at 18:57
  • @Victor123 in my actual scenario there is a 0.08 difference in fee structure, but I'm trying to understand the reinvestment tax implications between very similar funds, whose only difference is mutual fund vs etf
    – pyInTheSky
    Mar 26 '15 at 19:45

The ETF is likely better in this case.

The ETF will generally generate less capital gains taxes along the way. In order to pay off investors who leave a mutual fund, the manager will have to sell the fund's assets. This creates a capital gain, which must be distributed to shareholders at the end of the year. The mutual fund holder is essentially taxed on this turnover. The ETF does not have to sell any stock when an investor sells his shares because the investor sells the shares himself on the open market. This will result in a capital gain for the specific person exiting his position, but it does not create a taxable event for anyone else holding the ETF shares.

  • 1
    This is the best answer. If you hold a mutual fund through a market panic, you will get burned in capital gains due to other fund participants demanding redemptions. ETFs rarely have to sell assets as they can exchange assets for fund shares (via creation units). This is an "In-Kind" transaction and considered non-taxable. The tax burden is shifted to the Authorized Participants, who are hedging the underlying and trading shares for capital gains.
    – Andrew
    Dec 4 '15 at 15:13
  • Thanks for your answer. 2015 certainly made the case for the ETF. I was lucky enough to stumble onto this answer elsewhere, before seeing your response, and mitigate the capital gains of my munis by tax loss harvesting in Dec, and moving from munis to the equivalent ETF!
    – pyInTheSky
    Feb 4 '16 at 23:52

The main difference between a mutual fund and an ETF are how they are bought and sold (from the investors perspective).

An ETF is transacted on the open market. This means you normally can't buy partial shares with your initial investment. Having to transact on the open market also means you pay a market price. The market price is always a little bit different from the Net Asset Value (NAV) of the fund. During market hours, the ETF will trade at a premium/discount to the NAV calculated on the previous day. Morningstar's fund analysis will show a graph of the premium/discount to NAV for an ETF.

With a mutual fund on the other hand, your investment goes to a fund company, which then grants you shares while under the hood buying the underlying investments. You pay the NAV price and are allowed to buy partial shares.

Usually an ETF has a lower expense ratio, but if that's equal and any initial fees/commissions are equal, I would prefer the mutual fund in order to buy partial shares (so your initial investment will be fully invested) and so you don't have to worry about paying premium to NAV

  • 1
    This answer - despite being accepted - really fails to grasp the question that was asked. The question is about the tax differences in the two types of holdings. (See clarification by the OP in the comments.) The answer here does not address that at all. (In addition, the discussion about NAV is misleading / wrong. The "NAV" is at best a snapshot of value at a single moment in time, and that time is arguably not even representative of the market since there's extra activity at the close. There's nothing so important about it that yesterday's NAV should dictate today's value.)
    – user32479
    Dec 4 '15 at 4:39
  • 1
    This answer is totally off base and absolutely should not have been accepted. Any passive investor shouldn't be dabbling with ETFs that trade at a meaningful premium/discount. As far as NAVs go, mutual funds get End-of-Day pricing (unknown when you place your trade) and ETFs have a bid/ask spread that is known when you place your order. You also have the advantage of placing stops or limits, which makes NAV even more irrelevant (who cares about a $0.01 premium when intraday range is ~$1.00?).
    – Andrew
    Dec 4 '15 at 15:17

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