Should You Follow the Rich and Invest in ETFs?

Dawn Allcot
Street, City Street, Mobile Phone, Smart Phone, Smiling.
Street, City Street, Mobile Phone, Smart Phone, Smiling.

Americans making more than $1 million a year could pay double the rate on the investment income earnings under President Joe Biden’s new tax plan. By doubling capital gains tax to 39.6% for this demographic, Biden is seeking to not just pay for the recent stimulus packages but also address income inequity between the country’s wealthiest and those at poverty level, according to a report from Bloomberg.

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But, as expected, wealthy investors are likely to find a way around the tax hikes, by moving money from mutual funds and stocks to exchange-traded funds, say the experts. David Perlman, an ETF strategist at UBS Global Wealth Management told Bloomberg that even incremental hikes in capital gains taxes could push wealthy investors to ETFs as an alternative.

Why ETFs Are Different From Mutual Funds for Tax Purposes

When an investor cashes out a mutual fund, the fund’s manager sells securities to raise money for the transaction. With an ETF, on the other hand, the investor sells shares to another investor, which means no money has changed hands from a taxable standpoint, reduces capital gains tax, explains Bloomberg. ETFs have a 0.92% lower tax burden on average, than active mutual funds, which can really add up when you are talking about transactions of hundreds of thousands of dollars or more.

Why You Should Be Considering ETFs Now, Too

Private retirement accounts and other investments held by not just the wealthy, but also the middle class, rely heavily on mutual funds. If wealthy investors and hedge funds reduce their positions in mutual funds to move to ETFs, the value of mutual funds could drop.

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That’s probably not cause for alarm or worry that your retirement investments will tank. Not all experts feel the tax hike will affect mutual funds or ETFs. Michael Zigmont, head of trading and research at Harvard Volatility Management told Bloomberg that wealthy investors would trigger tax liabilities if they sold now.

But, if you have a choice between ETFs and mutual funds today, ETFs may prove a better investment in the future simply because they could rise if more money gets funneled their way.

However, even if ETFs don’t jump as a result of the new tax law, they could be an investment worth considering in your diversified portfolio. As with retail stock trading and many other investments, some companies permit commission-free trades on ETFs, and you can even consult with investment professionals before you make a trade.

The Bottom Line: You’ll Need to Buy Full Shares for Low Volatility

While some stock trading platforms allow you to purchase fractional shares – small portions, basically – of stocks, you will likely have to buy a full share of any ETF. But with prices starting as low as $50 right now, based on the Vanguard investment website, many ETFs are still fully accessible to most people ready to invest.

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In addition to the tax benefits of ETFs over mutual funds, ETFs are easy to buy and sell without help from an investment firm. ETFs tend to be less volatile than stocks because they represent a mix of companies, typically from the same sector. For greater security, risk management, and a more diversified portfolio without having to track, manage, and invest in multiple stocks, ETFs can be a great way to kickstart your investing income or bolster your portfolio.

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This article originally appeared on GOBankingRates.com: Should You Follow the Rich and Invest in ETFs?

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