Tax Structure of ETFs
Along with low fees, ETFs are a good addition to your portfolio because of their tax efficiency.
ETFs are known for being inexpensive investments but they do entail certain costs: the most prominent is the operating expense ratio (OER). The expense ratio is the annual cost for the fund to cover portfolio management, administration and others relating to the assets you hold. This ratio depends on the number of assets and how long you hold the ETF for. For example, the OER is more relevant for long-term ETF holders than short term investors. Most recently, a lot of issuers have launched similar ETFs, which track the same market index, with a lower OER.
Other costs include commission, bid/ask spread and discounts to NAV. Commission costs have become less significant with brokers like Charles Schwab offering commission-free trading however this cost is based on your broker. Essentially, the more you trade, the more you’ll pay in commission costs. You can think of the bid/ask spread as a commission cost too as the larger the spread and the more frequently you trade, the more significant this cost becomes.
If you bought shares of an ETF when it was trading at a premium to the NAV but then it drops to a discount, the difference between the two values is the cost to you. For example: if the ETF was bought at 0.5% premium and then drops to a 0.5% discount, you incur a 1% cost. As an investor, you should be aware of the risks involved, even if it’s just a small loss.