%0 Journal Article %A Ranga Nathan %T Tax Benefits of Exchange-Traded Funds %D 2003 %J ETFs and Indexing %P 81-87 %V 2003 %N 1 %X Investors in mutual funds may have to pay capital gains taxes in some years, even if they do not sell the fund shares. This can even happen in years in which the value of the investment decreases. Tax payments during the holding period represent a distortion, which reduces the rate of return from the investment. Exchange-traded funds (ETFs) were not designed as a tax shelter. But their structure, almost serendipitously, helps minimize, if not eliminate altogether, this distortion. This article explains the structural differences between mutual funds and ETFs. It lists the “tax events” within funds, and describes how the structural differences enable a different tax accounting within an ETF, when compared to that within a mutual fund. It discusses how the frequently occurring tax events within a mutual fund, arising from redemptions, can be completely eliminated within an ETF. It also illustrates, with the help of a study, how the infrequent but large mutual fund tax events, resulting from index re-constitution and corporate actions, can be minimized or completely eliminated within an ETF. The article develops the case for the tax benefits of ETFs from first principles and is therefore intended for retail investors who may not be familiar with tax treatments of capital gains and fund structures. %U https://guides.pm-research.com/content/iijetfind/2003/1/81.full.pdf