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Originally Posted by the buck
Couple of dumb questions:
1. Am I correct in understanding that an etf is just a name for "some bundle of stuff traded on a stock exchange" which can't conveniently be called anything else? Like suppose there existed a way to bundle some gold, some 300 of the 500 companies on the S&P500 in an index, and a few bonds in one thing, it could be called a blah blah blah etf, and today it could be worth $25 (per what? share?) and tomorrow $30?
There are different kinds of ETFs, but the majority of people think of them in one simple way, as it is the most common.
The Exchange Traded Fund, in that simple facet, is nothing more then a mutual fund that can be bought and sold during the trading day. Mutual Funds are bought and sold at an end of day Net Asset Value - which may or may not be the highest or lowest point during the day. ETF's give investors the flexibility of making decisions about a mutual fund and potentially get a better price then the end of day NAV. While this is an argument point by those such as John Bogle (founder of Vanguard) as it gives investors who might normally be buy and hold the opportunity to
trade and this will adversely effect their performance due to commissions and just straight up making bad decisions.
But to your point about bundling a bunch of things together? Yes, there is nothing preventing fund companies from doing that - and there are some funds that are purely derivative based that do things like that. But if the fund cannot be understood simply, it should be avoided.
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2. When people say etf's (and other vehicles) are "tax-efficient", do they simply mean that there are no dividends, i.e. only earnings are capital gains when they are sold, i.e. one pays capital gains tax as opposed to income tax (typically higher than capital gains tax)?
No, dividends are paid in funds that hold stocks. The tax efficiency comes from the bundling of dividends and that many ETFs that are stock based track indexes. Indexes are not actively managed and have low turn over. Therefore capital gains are limited as most indexes do not change their "holdings" frequently. With regard to the bundling of dividends - not all companies payout at the same time. Mutual Funds and ETFs put out dividends at normal intervals, regardless of when their holdings paid out. It becomes inefficient to pay out different tax lots.