SMAs, ETFs and Mutual Funds Explained - Rex Behrashi, CFP ®

Investors are constantly looking for ways to maximize investment growth while minimizing their tax burden. SMAs, ETFs, and mutual funds are three common investment types that offer investors different advantages and disadvantages. Understanding the basics, tax efficiencies and capital gain distributions are the first steps to gaining insight into where your money is invested or to make viable changes according to your investment strategy.

Uncovering the Basic Structure

Both mutual funds and ETFs take a one-size-fits-all approach while SMAs can be tailored to meet your investment needs. Exchange Traded Funds, referred to as ETFs, remain a low-cost investment style, giving investors access to the different advantages of indexing. Similarly, a mutual fund is a managed investment account that is composed of stocks, bonds, and other assets. The public has access to ETFs and mutual funds, meaning the investment makeup cannot be altered. However, if you have enough assets, you may qualify for a separately managed account, known as SMA, which is a professionally managed investment portfolio designed to fit your specific strategy. SMAs offer greater flexibility and can be created to mimic an investment strategy similar to a mutual fund or ETF.

Looking Into Tax Efficiencies

Analyzing the tax efficiencies can help you decide on which investment type is right for your needs. The structure of SMAs allows investors to benefit from tax-loss harvesting, which is selling investments that are generating a loss or are underperforming. The loss is then used to offset any capital gains you may have for the year. On the contrary, ETFs and mutual funds don’t retain as much flexibility for tax-harvesting; however, they do have tax benefits. ETFs have improved tax efficiency because of the minimization of active manager fees.

SMAs generally offer investors a higher tentative increase in returns post-tax; however, ETFs may still be more tax-efficient compared to mutual funds, with the overall tax bill being reduced. Mutual fund managers constantly engage in the sale of securities to account for redemptions, which may result in capital gains depending on the cost basis and sale price. On the flip side, ETF managers balance the assets being sold and bought through creation units that consider the overall risk exposure. Regardless of employing tax-efficient strategies, SMAs are still more productive for tax-harvesting.

Weighing Capital Gain Distribution

All investments offer different advantages and disadvantages when it comes to capital gains. SMAs give investors the highest level of capital gain flexibility because of tax harvesting capabilities; however, the fees remain heightened compared to other options, offsetting the advantages. ETFs and mutual funds have a lower level of capital gain tax planning. Effectively timing the sale of investments to minimize your capital gain distribution takes more planning and preparation when using ETFs and mutual funds. Overall, the method right for your investment needs will be based on a variety of different factors.

Considering Which Investment Type is Right for You

SMAs usually have a minimum asset dollar amount needed to open an account. This range can be anywhere from $100,000 to $5 million depending on the investment company. ETFs and mutual funds are an option if you don’t have enough assets to meet the minimum SMA threshold or you are a non-taxable investor. However, if you are looking for added flexibility and strategic investments, SMAs may be most beneficial to you due to the ability to implement tilts and social responsibility factors.

Summary

Understanding the key characteristics, tax efficiencies, and capital gain distributions of ETFs, SMAs, and mutual funds is key to picking the right investment for your situation. Choosing the right option can be a difficult decision, which is why it’s best to consult with an expert. BLU Financial Planning has been helping clients uncover the right strategies for their investment needs for over 15 years. Reach out to a team member today to get started.