Tax Talk: ETFs vs. Mutual Funds

Last week was the week to file your taxes and I'm sure we're all thinking about the tax efficiency of ETFs, especially when $23.8 billion was paid out by mutual fund shareholders for 2006.

Penelope Wang for Money Magazine reports that one cause for the hefty tax bill was was due to the fact that steep losses from 2000-2002 could no longer be carried forward.

We all know ETFs are tax efficient, but exactly what tax advantages do they serve over index mutual funds? Jane J. Kim for The Wall Street Journal explains that capital-gains payouts are rare and ETFs don't sell their holdings to meet shareholders redemptions, avoiding other capital gains issues.

On average, the "tax-cost ratio" for ETFs is 0.54% over the past five years. This is a measure of the amount of annual return lost to taxes. Over the period, the average index fund looses 0.67%.