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How to Pick the Best ETFs For Taxes For Your Portfolio in 2015

NEW YORK (TheStreet) — Investors now have about $2 trillion invested in nearly 2,000 different exchange traded products (the umbrella term for exchange traded funds and similar products). The ten biggest ETFs account for 28% of all ETF assets. But the biggest and most popular ETFs (such as ) are not always the best option for investors. Must Read: 16 Rock-Solid Dividend Stocks With 50 Years of Increasing Dividends and Market-Beating Performance In fact, the performance of the biggest and oldest ETF is held back by unnecessary cash drag and the most popular gold ETF comes with a tax surprise. How can you avoid surprise drawbacks and pick the best in class ETF? A brief mix of ETF history and trivia will shed some light on the often misunderstood, but important intricacies of these popular products. ETF History January 29, 1993: The first ETF is born, the SPDR S&P 500 ETF: SPY. SPY is structured as unit investment trust. March 12, 1996: ETF firm iShares releases the first series of ETFs structured as open-ended funds. At the end of the year 2000, there were 75 ETFs, all equity ETFs. July 22, 2002: The first non-equity ETP starts trading, the iShares iBOXX Investment Grade Corporate Bond ETF. November 12, 2004: SPDR Gold Shares becomes the first commodity ETP, structured as grantor trust. December 9, 2005: The first currency ETP is released, the CurrencyShares Euro ETF. April 10, 2006: The United States Oil Fund becomes the first commodity ETP structured as limited partnership. Need for Change Up until November 2004, every ETF was either an open-ended fund or a unit investment trust. To expand ETFs beyond equity and fixed income, ETF providers took advantage of additional product structures. By June 2006, there were five different ETP structures: Unit investment trust Open-ended funds Grantor trusts Limited partnerships Exchange traded notes This financial ingenuity set the stage for all sorts of ETF variations. In addition to equity, fixed income, commodity and currency ETFs, ETF providers launched products linked to exotic assets, such as global carbon credits, forensic accounting, insider sentiment, merger arbitrage, and more. The term exchange traded fund, initially applied to plain vanilla equity ETFs, no longer captured all the innovative ETF offshoots. Exchange traded product is now the commonly accepted umbrella label. Must Read: 10 Stocks Carl Icahn Loves for 2015: Apple, eBay, Hertz and More Structural Variations and Performance Let’s illustrate the effect of structural variations via the most popular S&P 500 ETFs. The S&P 500 SPDR is both the oldest and biggest ETF, with $190 billion in assets. As a unit investment trust, the ETF provider must fully replicate the underlying index at all times and dividends must be held in cash until paid out (quarterly). Dividends cannot be reinvested, which creates a dividend drag during climbing markets. The iShares Core S&P 500 ETF and Vanguard S&P 500 ETF on the other hand are open-ended funds. As such, they are allowed to reinvest dividends. Furthermore, IVV and VOO are not required to hold all 500 of the underlying S&P 500 stocks and theoretically could (although it doesn’t really happen in reality) use a less expensive optimization approach to replicate the S&P 500’s performance. VOO and IVV outperformed SPY in 2012, 2013 and 2014 by about 0.06% per year. Structural Variations and Taxation 1,019 ETFs (62% of the ETP universe) are built on the open-end funds chassis. The table below categorizes ETPs according to asset class and product structure. Listed are the top ETPs of each matrix (based on assets under management) along with the number of ETPs belonging to each category. Long-term open-ended fund gains are taxed as ordinary income (maximum 39.6% and 20% short-term). The same is true for Unit Investment Trusts, which includes the popular S&P 500 SPDR, Dow Diamonds and PowerShares QQQ. Exchange traded notes are also taxed at a maximum of 39.6% (long-term) and 20% (short-term). The exception is currency ETNs, taxed at a maximum of 39.6% (long-term) and 39.6% (short-term). Physical gold or silver ETFs, such as the SPDR Gold Shares or iShares Silver Trust. are treated as collectibles and, within a grantor trust, taxed at a maximum of 39.6% (long-term) and 28% (short-term). From a taxation perspective, it might make more sense to buy a gold or silver ETN, but in reality there aren’t many heavily traded alternatives. Futures-based commodity and currency ETPs, structured as limited partnerships, are subject to a unique taxation formula: 60% of any gains are taxed at the long-term capital gains rate of maximum 20%, and 40% are taxed at a maximum 39.6%. The blended maximum tax rate is 27.84%. All in all, there are over 30 different taxation variations. Obviously I am no tax advisor and this is not intended to be tax advice but I’ve put together a simple cheat chart that list all the different tax treatments and rates. It is available here: ETP Taxation Cheat Sheet. Once you’ve identified the best in class ETPs, the next step is easy: Buy low and sell high. Must Read: 16 Rock-Solid Dividend Stocks With 50 Years of Increasing Dividends and Market-Beating Performance

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