Investors in exchange-traded funds (ETFs) typically enjoy greater tax efficiency compared to mutual fund investors, mainly due to the unique legal structure of ETFs. Bryan Armour of Morningstar notes that ETFs utilize “in-kind creations and redemptions,” minimizing capital gains distributions that trigger tax bills. For instance, over 60% of stock mutual funds distributed capital gains in 2023, while only 4% of ETFs did. This tax advantage is significant for taxable accounts, as it doesn’t apply to retirement accounts like 401(k)s or IRAs. However, some ETFs, especially those involving physical commodities or certain international securities, may not benefit from this tax efficiency.
