Some of the reasons for popularity of ETFs include tax efficient investments, low expense ratio, maintain inherent liquidity, offers diversity in single investments, provide intraday trading access, & some trade commission-free through participating brokers.
You should wisely invest in an ETF only after understanding the fund’s legal structure & corresponding implications along with financial risks & tax treatment. This critical information about a fund can be obtained from its prospectus.
There are 5 types of exchange-traded products, including ETFs:
(a) Open-End Funds
Most of the ETFs use open-end structure. These funds are registered with SEC (Securities and Exchange Commission) under the Investment Company Act, 1940. They can issue any number of shares depending on the demand of shares without any restriction. Here, dividends are reinvested on the same day of receipt while cash distributions are paid to shareholders every quarter.
(b) Unit Investment Trusts (UITs)
It is also regulated by SEC under the Investment Company Act, 1940. It is an exchange-traded mutual fund that offers a fixed portfolio of securities with an expiry date. Here, dividends are held until they are paid to shareholders on a quarterly basis.
(c) Grantor Trusts
These are fixed investment portfolios that can’t be changed at a later date. It is tax-efficient investment options where you can control taxes by deciding when to sell stocks. Here, dividends are distributed to shareholders immediately. Investors are known to have same voting rights as that of shareholders of a company.
(d) Limited Partnerships (LPs)
It is a form of partnership that involves two or more partners with presence of at least one general partner & at least one limited partner. These funds usually invest through future contracts & are taxed every year even if you still own the position.
The capital gains are taxed at 60% for long-term & 40% for short-term. Here, dividends may or may not be reinvested.
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